Are ETFs a Good Fit for Your Retirement Portfolio?

ETFs can be a great choice for active investors and can offer savings that blow mutual funds out of the water.

Jan 17, 2014 at 6:39PM

ETFs (exchange-traded funds) can be a great addition to your retirement portfolio at any stage in the game. Whether you are a new investor or are nearing retirement, ETFs can be the perfect solution for diversifying your portfolio and gaining market exposure while keeping expenses low.

While ETFs have many upsides, there are some things you should consider before jumping in.

How active of an investor are you?
One of the biggest advantages ETFs offer in contrast to mutual funds is that they can be traded like a stock, but they generally require more work than investing in mutual funds.

Bid-ask spread
Liquidity can make a big difference when it comes to trading ETFs. The more heavily traded an ETF is, the smaller the bid-ask spread will be. In a heavily traded ETF, the bid-ask spread naturally narrows because there are plenty of buyers and sellers.

For example, iShares MSCI Emerging Markets (NYSEMKT:EEM) is a heavily traded ETF. Averaging around 63.5 million shares in daily trading volume for the last three months, this ETF is unlikely to have a bid-ask spread of more than a few cents at any given time. A heavily traded fund like iShares MSCI Emerging Markets is optimal for investors who do not want to spend hours watching the bid-ask spread waiting for just the right moment to pull the trigger.

Premium/discount
Similarly, ETFs trade at a premium or a discount. Unlike mutual funds, which trade at a single price for the day, ETFs trade at a premium or discount in relation to their underlying net asset value. For investors who buy and hold, this is less important. If you are an investor who has entered the ETF market because you like to trade a lot, however, it is important to be aware that bid-ask spreads and premiums and discounts can affect your returns positively or negatively over the long run.

An extreme example of premium/discount swing is iShares MSCI Philippines (NYSEMKT:EPHE), which experienced a more-than 10% swing in premium and discount over nine days last June. Investors looking to make a large buy at that particular moment could have unknowingly become winners or losers without even trying. This low-volume ETF also experiences big gaps in bid-ask spread because it does not trade nearly the volume of other ETFs. This fund only trades an average of about 200,000 shares on a daily basis, and bid-ask spreads can be more than $1.50 per share. Compare that with iShares MSCI Emerging Markets, which trades 185 times that many shares in a single day on average and usually has a bid-ask spread of about a penny.

Automatic investing
Many investors like to put their savings on autopilot. If you prefer to "set it and forget it," investing in mutual funds may be a better choice. Most brokerages offer periodic investing options for mutual funds on a monthly, quarterly, or annual basis. Periodic investing is only available for mutual funds, not ETFs. Investors who like to dollar-cost average by spreading their buys throughout the year should consider sticking with mutual funds. Most brokerages waive fees for periodic investing and allow investors to make smaller buys after their initial buy into the fund. Keep in mind that if you choose to purchase ETFs on a monthly basis instead, there are usually fees that will accompany each trade.

Will ETFs help you reduce fees?
Nothing erodes the value of a retirement account faster than fees. They may seem small, but over time they add up. Over the course of 30 or 40 years of saving, the difference of 1% in fees can be the difference between retiring comfortably and having to work a lot longer.

ETFs offer tremendous value when it comes to fees. For example, Vanguard FTSE Emerging Markets ETF (NYSEMKT:VWO) offers investors exposure to mostly large-cap emerging-market stocks at a very low 0.18% expense ratio. Given the net average expense ratio of 0.58% for the category, investors who buy and hold stand to save a substantial amount of money over the long term.

ETFs are often less expensive than their mutual-fund counterparts. While the expense ratios of ETFs may be lower than a mutual fund with similar holdings, it is important to factor in other expenses, such as commission charges. Some brokerages offer commission-free trades on certain ETFs. This can be a great way to save money in fees when trading ETFs; however, it is important to carefully examine the ETF to make sure it will help you meet your goals. Cheap doesn't always mean good.

The No. 1 Way to Lose Your Wealth Without Even Knowing It
You've fought hard to build wealth for you and your family. Yet one all-too-common pitfall could completely derail your dreams before you even know it. That's why a company The Economist hails as "an ethical oasis" has isolated five simple questions you must answer to ensure that your financial future is really secure.

Can you answer YES to all five of these eye-opening questions?
Click here to find out -- before it's too late!

Fool contributor Melinda Melendez has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers