Giddy up! At more than 21,000, the Dow Jones Industrial Index has soared by 1,200 points or about 13% since January 2017. If you consider the run-up since February 2016, the stock market has delivered a staggering return of about 30%. The stock market has been on the best winning streak in 25 years.

One fundamental reason for the stock market rally is linked to the growth of Exchange Traded Funds, or ETFs, as retail investors have poured in $124 billion into this type of an investment vehicle in 2017 alone.

State Street Corp.’s SPDR S&P 500 ETF is the market’s oldest, largest and the most-traded security in the world.

Love Thy ETF

Introduced in 1993, ETFs, or Exchange Traded Funds, trade on an exchange like stocks. An ETF is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike actively traded mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold.

ETFs typically have lower fees than mutual funds, making them an attractive alternative for individual investors. Shareholders do not have any direct claim on the underlying investments in the fund, instead, they indirectly own these assets.

According to research firm XTF, there are around 1,800 ETF investment vehicles holding stock worth more than $2.7 trillion. There are no SEC rules governing ETFs which means ETFs are regulated via mutual fund regulation. Just three firms

—     BlackRock Inc.

—     State Street Corp.’s State Street Global Advisors

—     Vanguard Group

manage 80% of ETF assets.

ETF vs Actively Managed Funds

  • ETFs try to track the performance of a particular market benchmark, or “index,” as closely as possible. In contrast, Actively Managed Funds (AMFs) try to outperform their benchmarks and peer group average.
  • ETFs buy all (or a representative sample) of the securities in the benchmark, while AMFs combine research, forecasting, and experience/expertise of a portfolio manager or management team.
  • Index funds tend to be more tax-efficient and have lower expense ratios than actively managed funds because they trade less frequently than AMFs.
  • Although AMFs attempt to beat the market, quite often they may also miss their targets which results in losses for the funds’ investors. In contrast, ETFs are only undertaking the underlying risk of the market benchmark.
  • Most importantly, AMFs typically charge between five and twenty-five times what ETFs charge their investors.

Not surprisingly, the pace of ETF inflows bodes negative news for asset managers. Investors have started pulling their investments from AMFs to ETFs. The largest providers of ETFs have started reducing management fees to attract even more funds. The average annual fee of ETFs bought this year is only $23 for every $10,000 invested, sharply lower than last year. Some ultralow-cost iShares Core funds cost as little as $4 a year for a $10,000 investment, which is can be about 1/25th fraction of the fees charged by most mutual funds.

Given the low-cost structure of ETFs and the raging bull market, $7.5 billion has moved into the iShares Core S&P 500 ETF and $5.4 billion into the Vanguard S&P 500 ETF in January 2017 alone!

Hamiltonian Hip Hop and ETFs

Lately, the US stock market has generated staggering returns unmatched by almost any other country. Take for instance the returns generated from an investment in S&P 500 stocks in the last eight years.

  • 2009                26%
  • 2010                15%
  • 2011                2%
  • 2012                16%
  • 2013                32%
  • 2014                14%
  • 2015                1%
  • 2016                12%

If you invested in the S&P 500 from 1928 to 2014, the per annum compound rate of return was 9.8%. Thus, if you invested $100 in 1928, your nest egg would become $346,261 in 2014.

Join and celebrate the US goldilocks economy and consider becoming an ETF shareholder.

Vermont, February 10, 2017

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