But after the product got off the ground, people started to pick up on the advantages, including the tax benefits and investment diversification opportunities.

“In the early 2000s, we began shifting client assets from mutual funds to ETFs,” said Lydon, (who is also a columnist for Financial Advisor). “Some of the reasons were expenses were much cheaper. They were tax efficient, pretty well diversified. On top of that, in the early 2000s after that run-up in the 1990s, a lot of these [mutual fund] companies were rich with new cash. A lot of them started slopping on redemption fees and some even started closing the funds. With ETFs, it was great because you didn’t have to ask permission to come in and you didn’t have to apologize when you leave.”

Baghai said that ETFs have changed financial advice, since they have allowed for a broad shift to fee-only planning.

“Obviously, the ETF has in our minds helped with the pace of change from commission based to fee-based,” she said. “And in essence it has allowed the fee-based advisor to become more of the CIO or the tactical asset allocator for their client as opposed to being what some would lovingly call the stock picker.”

Ross added that fee advisors can now buy instant exposure to a sector and hundreds of stocks, which helps their investment model.  

“In a world where the platforms and the home offices are very focused on revenue share and advisors have historically been focused on fee-based commissions, obviously the ETF challenges fundamentally those economics. And you also have various other [ETF] firms who have shifted towards no fees at all for their proprietary ETFs.”

With that talk of a price war comes rumors that funds will emerge with 0 percent expense ratios. (Charles Schwab, in fact, has just launched a new platform, "Schwab ETF OneSource," a new no-commission, no-transaction-fee ETF program.)

As the competition increases, Ross says education becomes more important, and it’s not necessarily best that all investors only gravitate to the lowest price. He said the underlying bid/ask spreads and liquidity can affect the performance, depending on whether a fund is trading hundreds of shares or only 10. With short-term trading, it can make a difference if the trading costs outpace a fund that’s only, say, 5 basis points cheaper than another.

“The easiest thing to understand is the expense ratio, but the expense ratio doesn’t give you the whole story,” says Ross. “Understanding some of the mechanics underneath the trading is really important.”

First « 1 2 » Next