In a survey of investing trends released in June by the Journal of Financial Planning and the FPA Research and Practice Institute, exchange-traded funds were named the top investment vehicle of choice among financial advisors. It wasn’t always that way, but from the launch of the first U.S.-listed ETF in 1993 through today, these products have slowly but steadily gained favor with advisors—83% of whom said they used or recommended ETFs in 2016, up from just 40% in 2006. 2016 is the second consecutive year that ETFs ranked highest among 18 options posed by the annual trends survey. Some advisors use them more than others. 

Rose Swanger is the principal at Advise Finance LLC in Knoxville, Tenn., which has essentially become an ETF-only shop. She explains how and why she now relies on ETFs for her clients’ portfolios. 

Schlegel: Please describe your practice, your client base, and your role with them regarding their investments.

Swanger: I have personally managed all my clients’ assets for many years. Until recently, I started to add some third-party managers for some clients’ portfolios to comply with the upcoming Department of Labor fiduciary rules. 

My clients are from all walks of life, from doctors to truck drivers. But I aim at the mass affluent, whose investible assets range from $150,000 to $1 million. 

Schlegel: When did you start using ETFs?

Swanger: I experimented with ETFs for my own portfolio in 2008. Once I became familiar with them, I started to add ETFs in my clients’ portfolios in 2011. I like to use analogies to describe nebulous and difficult investment terminology to clients. So when I explained my portfolio design to them, I described ETFs as sort of like the fraternal twins to mutual funds. They invest in the same assets, but ETFs offer much more advantages such as trading flexibility, lower expense ratios, etc. Clients understood how mutual funds worked, so there wasn’t much surprise or resistance to the switch to ETFs. 

Schlegel: What did you primarily use before you switched to ETFs?

Swanger: Mutual funds. I now have only one client with mutual funds. He has four funds—and they’re all really good funds that are closed to new investors. I’m debating whether or not to change those over to ETFs. Other than that, all of my clients use ETFs right now.

Schlegel: What is the attraction of ETFs?

Swanger: The main attractions of ETFs are the low cost and tax efficiency due to their process of share redemption, which minimizes capital gains distributions to clients. Capital gain distributions can be a huge tax headache for many clients who are in a high tax bracket and use mutual funds in their taxable account. ETFs help alleviate that problem, and that can be music to my clients’ ears. 

In addition, ETF expense ratios on average are much lower versus traditional mutual funds, according to one of the Morningstar reports. Every bit of savings translates into a possible higher return to the investor. 

Schlegel: Describe the progression of how ETFs took on a bigger role in your practice.

Swanger: Like I mentioned before, I did some comparison in my own portfolio. One was invested with mutual funds; the other used ETFs. Not only did the one with the ETFs show a higher return, but it also kicked off lower capital gains. Naturally, I started to progress with more ETFs into the portfolio designs. 

Other than costs and taxes, there are two additional advantages with ETFs. One is the trading flexibility. Mutual funds trade just once a day at the end of the trading day, but you can trade ETFs throughout the day. The disclaimer on that is that’s not meant to encourage more trading because the costs can add up quickly. 

Furthermore, you can set up stop-loss orders or limit orders for the ETFs. That can be attractive for retirees, who are jittery about losing money in a sudden market downturn as they don’t have regular income to count on. They need to protect what they can. However, this strategy can have some downfalls. In case of a flash crash, the limit and/or stop-loss order can be activated instantly. So it’s really important to know your clients and how much risk they can tolerate, based on their investment horizon. 

Schlegel: Describe the investment strategies and types of funds you use to meet your clients’ needs. 

Swanger: The strategies are very individualized based on each client’s personal risk profile. Some people might want more income; others might want more growth because they’re young. So I design my portfolios around their goals and needs. I frequently look up resources, such as Morningstar, for their reviews and analysis. I’m mindful about the cost for each ETF when deciding which ETFs to choose. 

Besides the aforementioned benefits of ETFs, another favorable characteristic worth mentioning is that unlike mutual funds, which sometimes close their doors to new investors once they reach a certain asset size, ETFs don’t close unless they’re terrible to start with. 

When it comes to investing, I like to keep it simple. I use broad-based, low-cost index funds for all domestic, international and emerging markets investments.

Schlegel: Do you mainly rely on a particular fund family, or do you shop around?

Swanger: As much as I love Vanguard’s low-cost funds, I am a price-conscious investor. I look for other fund families for comparison first.

Schlegel: Are there any drawbacks to relying on ETFs?

Swanger: At the present time, there is no balanced ETF fund, or at least not one with some kind of track record that has garnered a Morningstar review. A balanced mutual fund has both the equity and fixed-income portions within the same fund, and that can be useful for a new investor who wants the diversification but doesn’t have much money to work with. If they want to follow a balanced strategy with ETFs, they would need to buy two ETFs [one focused on equities, the other on fixed income] for a diversified portfolio.