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.