Why You Should Invest in ETFs

A big reason is that almost 60 percent of new investor money goes into 401(k)'s, so the next big leap for the ETF industry is 401(k) plans. Unfortunately, we're years away from that, because the big ETF providers are not motivated to allow ETFs within their 401(k) plans. And although some mutual funds have been good performers, some huge 401(k)'s are chock-full of poor-performing mutual-fund choices. But we're seeing some steps being taken. Congress is passing more and more legislation for fund companies and corporations offering 401(k) plans to do a better job of disclosing fees and performance. Eventually, trustees will feel more pressure to cut expenses and provide better fund options. And 401(k) participants like you and I will put more pressure on companies we work for to offer better choices.

How many ETFs should make up a portfolio?
Typically, our clients will have 10 to 14 ETFs in a portfolio, and the average portfolio is around $1 million. That's not that many holdings. But when you look at underlying holdings of the indexes, they're very well diversified.

What ETFs do you like, given the current market?
One area that has been bucking the trend is biotechnology. Healthcare and biotech have been unloved and haven't had a run-up over the past three years. Also, there are a lot of biotech companies related to agricultural research—looking at better ways of developing seeds, for example—and many top-producing drug companies have patents that are about to expire, so we have a lot of big pharmaceuticals snapping up biotech companies with drugs in the pipeline and great ideas. An ETF I like is iShares Nasdaq Biotechnology Index (symbol IBB).

What do you think of actively managed ETFs?
I think they're great. Remember, there are thousands of actively managed mutual funds that charge high fees for poor performance. Actively managed ETFs have much lower fees. There's not a lot of turnover, so you're not going to have the distributions of conventional funds. There is an added tax advantage in ETFs. It's difficult to understand, but because a fund manager doesn't have to sell stocks and raise cash when money goes out of an ETF, the ETF doesn't have the inherent capital-gains exposure that conventional mutual funds have. In addition to low fees, that makes ETFs extremely attractive over the long term. Today, you're not going to see billions of dollars flowing in to active ETFs, but over time—because of the nature of the structure—they're probably going to outperform most of the actively managed conventional funds. These are also the types of ETFs we'll see in 401(k) plans down the road.

What else is new in the ETF industry?
One thing we've just seen recently is the introduction of a few frontier ETFs. They represent areas like the Middle East, Eastern Europe, and Africa—markets that you and I wouldn't normally have the opportunity to get into. These pre-emerging markets are starting to develop, and they're embracing global accounting standards, technology, and trade. It's a neat opportunity for investors who missed the whole emerging markets move. This might give them the opportunity, when global markets turn, to be in some of the new, hot areas.