Defining success in saving and investing is challenging; setting realistic goals is critical. Aiming too high requires excessive risk, increasing chances of failure. Seeking low, but stable, returns results in sure and steady loss of real value, as inflation and taxes punish already meager growth and income.
Beating inflation over time should be a primary goal for investors. Realistically, this requires at least some exposure to the stock market – the best reliable track to long-term positive real returns. For generations, investors and advisors have argued details of stock market investing. Market Indexes (or Indices, both acceptable) were developed as yardsticks for investors to measure their own success (or lack of same) against the market itself.
From early, high-commission stockbrokers plying their trade for the wealthy, emerged the Mutual Fund industry, which offered investments at reduced costs with increased diversification. Finally, an average investor could emulate a Market Index of choice, using a Mutual Fund designed to do exactly that. Investors were able to evaluate their own results by comparing them to Indexes. New investors eagerly jumped in, and the mutual fund industry flourished.
Nothing shouts success louder than imitation. Innovative people soon realized the positives and negatives of mutual funds, and began to conjure up a “better way.” Mutual funds are not truly free market tools. By law, trading activity only takes place between the buyer or seller and the fund company itself, not on an Exchange.
Evolving from mutual funds, beginning in the 1990s, emerged the Exchange-Traded Fund (ETF) industry, which offered similar diversification, but with added benefits of lower costs and flexible trading. From humble beginnings, the ETF industry has grown to over $7 Trillion in assets.
Investors have concluded that, claims to the contrary, “beating the market” over time is likely a pipe dream. Instead, observing the growth in various Market Indexes, matching that growth with personal results is a laudable and lofty goal. With the advent of extremely low cost Indexed ETFs, it became achievable. “Owning the Index” is impossible, because an Index is a number, derived from the value of the assets represented. Owning the Index Share, however, is readily accomplished, and provides nearly equal results, with only extremely low internal costs in most cases.
Many young investors use exclusively Index ETFs, until their portfolios grow enough to seek further diversification. Most wealthier investors retain Index shares as “core” holdings, and diversify further over time..
Next week we will further examine the ETF Industry’s offerings.
Van Wie Financial is fee-only. For a reason.
