Anyone paying attention to trends in the investment world knows that exchange-traded funds are red hot. In fact, total ETF assets reached the $1 trillion mark toward the end of last year. And it's easy to see why these investments are stealing market share from traditional actively managed mutual funds. ETFs are typically much cheaper and more tax efficient than active funds. Plus, they can be traded throughout the business day, instead of just once at the close of trading.
Of course, all this attention focused on exchange-traded funds has meant one thing to Wall Street types: profits. Thus, a flood of new products has washed onto the market in recent years. In fact, 58 new ETFs were introduced in the first three months of 2011 alone. And while investors can make do without the vast majority of these funds, there are a few brand-new ETFs that stand out as excellent options for a wide range of investors.
Schwab U.S. Mid-Cap ETF
Schwab has been working hard to make an impact in the competitive exchange-traded fund business. In the past year and a half, Schwab has introduced about a dozen broad-market ETFs with rock-bottom expenses, in an attempt to undercut market leaders iShares and Vanguard. For example, the Schwab U.S. Broad Market ETF
Schwab's latest entrant into the race is the U.S. Mid-Cap ETF. This fund tracks the Dow Jones U.S. Mid-Cap Total Stock Market Index, which consists of the mid-cap portion of the Dow Jones U.S. Total Stock Market Index. The fund holds roughly 500 issues, all solidly mid-cap companies, as indicated by the $4 billion average market cap across the fund's holdings. With a low 0.13% price tag, this fund is now one of the most inexpensive mid-cap ETF options in existence. If you want broad mid-cap exposure on the cheap, this fund should be one of your final candidates.
Vanguard Total International Stock ETF
Another new addition to the ETF field is Vanguard Total International Stock ETF, which launched in late January. This fund is designed to track the performance of the MSCI All-Country World ex-USA Investable Market Index -- basically everything outside of U.S. borders. The index includes the stocks of more than 6,000 companies in 44 countries, both developed and emerging. The price of admission is just 0.20% here.
Of course, Vanguard already offers similar ETFs that invest in these foreign regions, including the Vanguard MSCI EAFE ETF
And a few to avoid
Unfortunately, the two ETFs listed above are the rare exceptions to the onslaught of unnecessary and even potentially dangerous funds hitting the market this year. The majority of new ETFs introduced this year are leveraged offerings or specialty sector/country funds. And while some investors may be able to successfully use these funds within their portfolio, most of the people drawn to these investments are simply chasing returns or looking to gamble on the market -- or both.
For example, there are three new PowerShares ETNs on the market that offer 300% of the return of government-issued debt securities in Germany, Italy, or Japan. While you may want some dedicated exposure to these nations' debt, taking a levered 300% bet will work against most retail investors.
Likewise, several new ETFs from Global X Funds that focus on narrow segments of the market have also been launched. The funds include ETFs that invest in sectors such as aluminum, oil, and gold miners. Some investors can no doubt use funds like these correctly, but odds are that the majority of assets that will find their way into funds like these are just chasing returns. Hot recent performance isn't a solid justification for investing in an asset class, but the growing availability of ETFs that invest in these areas will ensure that a fair number of folks take just that route.
Ultimately, while exchange-traded funds can, and should, play an important role in every investor's portfolio, it's vital that you stick to broad-market, inexpensive funds. Avoid gimmicky, pricey funds with strategies that you don't understand or that invest in tiny slices of the market. Fortunately, there are a solid number of well-diversified ETFs with wide-ranging appeal already on the market, so most investors shouldn't worry about the influx of new products that will undoubtedly continue to flood the market.