ETFs for the Long Run

Praise for ETFs For The Long Run

"As the title of the book suggests, ETFs are going to be an increasingly important reality for a broad class of investors in coming years. This book offers the reader real understanding of this growing force in our economic lives."
—Robert J. Shiller, Arthur M. Okun Professor of Economics at Yale University, Co-founder and Chief Economist at MacroMarkets LLC

"ETFs for the Long Run is a fascinating read. A seasoned financial industry journalist, Lawrence Carrel does an excellent job of highlighting exchange traded funds' meteoric rise in popularity over the last few years. A terrific book for anyone looking to grasp the ABCs of ETF investing."
—Jerry Moskowitz, President, FTSE Americas Inc.

"ETFs for the Long Run provides a unique combination of a detailed history of the development of ETFs, a clear explanation of the sophisticated mechanics of ETFs, an assessment of investors' choices amongst this dynamic product area, and unbiased recommendations for appropriate portfolio allocation to these efficient investment tools. Lawrence Carrel has done investors and the industry a great service in pulling these four elements together in a highly readable and often entertaining book.
—Steven Schoenfeld, Chief Investment Officer, Global Quantitative Management, Northern Trust, and Editor, Active Index Investing

Despite the incredible growth of exchange-traded funds (ETFs) and the fact they've been on the market for fifteen years, some investors are still either unaware of the effectiveness of ETFs or unsure of how to use them in their investment endeavors.

That's why respected ETF expert and journalist Lawrence Carrel has written ETFs for the Long Run. Filled with in-depth insights and practical advice, this reliable resource puts ETFs in perspective and reveals how they can help you profit in both up and down markets.

Page by page, Carrel takes you through the ins and outs of ETFs, including their history, the tax benefits and minimal charges associated with them, and the fundamental differences between ETFs and other types of investments. He also provides you with the resources and tools needed to trade ETFs and build your own ETF portfolio.

You may have heard about ETFs while researching other investments or speaking with an investment advisor. If you want to learn more about them, this book will provide you with a clear understanding of what ETFs are, how they work, and how they can be used to create a low-cost, liquid, and diversified portfolio.

Preface ix

Acknowledgments xiii

Chapter 1 Etfs—The Newfangled Mutual Funds 1

How ETFs Stack Up against Mutual Funds 2

Greater Flexibility 3

Lower Fees 4

More Tax Efficient 5

Greater Transparency 6

Precise Allocations 6

Investment in Alternative Asset Classes 7

One Caveat 7

Summary 8

Chapter 2 Etf History Lesson: How A New Type of Fund Was Born 11

A Short History of the Amex 13

The Father of the ETF 17

Philly Strikes First 18

Back to the Drawing Board 21

Along Came a Spider 26

The Birth of an Industry 27

Let’s Do It Again 29

What Tangled Webs We Weave 30

Building a Business 33

Shine On, You Crazy DIAmonds 34

Arachnophobia? 35

Wedding Bells 35

The Biggest ETF Launch 37

All in the Family 41

The First Assault 45

If You Can’t Beat ’Em, Join ’Em 46

Builders and Bonds 47

Free Again 49

Chapter 3 The Evolution Of The Etf 51

The Importance of a Broadly Diversified Portfolio 53

The Appeal of Investment Companies 55

Types of Investment Companies 56

Types of Mutual Funds 58

Running a Mutual Fund 60

The Creation of an ETF 63

Summary 67

Chapter 4 Index Fund-Amentals 69

Why an Index? 70

Fund Management Options 72

The Rise of the Index Funds 76

The Big Index Companies 79

Indexes from the Stock Exchanges 82

Actively Managed ETFs 84

Summary 84

Chapter 5 Fee Bitten 87

Wall Street Produces Vintages 87

Looking for Low Management Fees 89

Summary 92

Chapter 6 the better mousetrap: how can etfs charge so little? 95

Transparent Costs of Mutual Funds 96

Hidden Costs of Mutual Funds 105

The Creation Unit: How They Make ETFs So Cheap 110

So Long, Transaction Costs 114

So What Costs Do ETFs Have? 119

Why Would I Ever Buy a Mutual Fund? 123

Summary 127

Chapter 7 The New Indexers 129

Missed Opportunity 132

Unfair Fight 136

BONY Builds a BLDR 137

The Name Is Bond 138

Rydex Rides In 140

Vanguard Makes a Splash 142

There’s Power in Them There Shares 144

Mutual Fund Scandal Helps ETFs 145

PowerShares Becomes a Powerhouse . . . and Other Important Developments of 2005 147

The Buy-Out 148

Opening the Floodgates 149

The Fundamentalists 155

Grow, Baby, Grow 163

Summary 168

Chapter 8 The Etfs That Aren’t Etfs: Etps, Etvs, And Etns 171

You’ve Got a HOLDR to Cry On 174

Exchange-Traded Notes 176

Commodity-Based ETVs 180

Money Makes the World Go ’Round 199

Summary 204

Chapter 9 Putting The “Trade” In Exchange-Traded Funds 217

Discount Brokers 219

The Actual Trade 220

Going Long to Go Short 226

Options on ETFs 229

Summary 232

Chapter 10 Building Your Own Etf Portfolio 235

The Simplest Portfolio 237

Assessing Your Risk 237

Strategic and Tactical Asset Allocation 241

Foundation Portfolios 248

Not Following the Herd 258

Tax-Loss Harvesting 265

Hiring an Investment Adviser 267

Summary 269

Chapter 11 The Future Of Etfs 273

The NYSE-Amex Merger 274

Specialists and Seed Capital 275

Actively Managed ETFs 279

Entering the 401(k) Market 281

In Conclusion 283

Appendix : How To Decide Which Etfs Are Best For You 285

Notes 289

About the Author 300

Index 301

"This book should go a long way to helping not just investors but top-notch financial professionals…" (Research Magazine)

LAWRENCE CARREL, as a senior writer, took over the weekly ETF and mutual fund columns at TheStreet.com in 2007. Prior to that, he created SmartMoney.com's "ETF Focus" column, a weekly look at the ETF industry from the individual investor's point of view. Before joining SmartMoney in 1999, Carrel was a founding member of the Wall Street Journal Online, where he covered the stock market, edited breaking news, and was one of the writers of the "Cyber Investing" column. Carrel holds a bachelor's degree in applied economics and management and communications from Cornell University.

Over the past few years, exchange-traded funds (ETFs) have gained wider recognition among retail investors and become a staple in the portfolios of many individuals. In addition to its flexibility and transparency, the ETF's ability to track asset classes besides stocks and bonds—such as commodities and currencies—has allowed investors to own a liquid, diversified portfolio for a minimal investment.

Respected ETF expert and journalist Lawrence Carrel knows how effective this financial product can be, and now, with ETFs for the Long Run, he'll show what they are and how they work—as well as outline simple strategies you can use to incorporate them into your investment endeavors.

The journey begins with a brief history of ETFs, who the industry leaders are, and how they got there. After this introduction, you'll become familiar with the fundamental differences between ETFs and other types of investments, such as mutual funds. You'll also discover the advantages that an ETF's indexing structure has over an actively managed product.

With this information in hand, you'll be prepared to delve into the nuts and bolts of the ETF and see why it's one of the most efficient ways to gain exposure to today's market. Page by page, Carrel skillfully examines the unparalleled benefits associated with ETFs, explores new exchange-traded vehicles (ETVs)—which are very similar to ETFs—and addresses innovations within this area that have created more diverse opportunities for today's individual investor. Along the way, Carrel also reminds us that while a fund's returns can't be known ahead of time, its costs can—so focusing on cutting those costs can save you thousands of dollars down the road.

Rounding out this detailed discussion of ETFs are two chapters dedicated to building your own ETF portfolio, touching on everything from the mechanics of trading to designing asset allocation strategies. Here, Carrel calls upon a select group of financial professionals to help you understand a wide variety of portfolio construction possibilities and implement the ones that best suit your investment style.

The basic challenge that every investor faces is creating a broadly diversified portfolio for the least amount of money. ETFs can help you achieve this goal, and ETFs for the Long Run will show you exactly how.

ETFs FOR THE LONG RUN

Over the past few years, exchange-traded funds (ETFs) have gained wider recognition among retail investors and become a staple in the portfolios of many individuals. In addition to its flexibility and transparency, the ETF's ability to track asset classes besides stocks and bonds—such as commodities and currencies—has allowed investors to own a liquid, diversified portfolio for a minimal investment.

Respected ETF expert and journalist Lawrence Carrel knows how effective this financial product can be, and now, with ETFs for the Long Run, he'll show what they are and how they work—as well as outline simple strategies you can use to incorporate them into your investment endeavors.

The journey begins with a brief history of ETFs, who the industry leaders are, and how they got there. After this introduction, you'll become familiar with the fundamental differences between ETFs and other types of investments, such as mutual funds. You'll also discover the advantages that an ETF's indexing structure has over an actively managed product.

With this information in hand, you'll be prepared to delve into the nuts and bolts of the ETF and see why it's one of the most efficient ways to gain exposure to today's market. Page by page, Carrel skillfully examines the unparalleled benefits associated with ETFs, explores new exchange-traded vehicles (ETVs)—which are very similar to ETFs—and addresses innovations within this area that have created more diverse opportunities for today's individual investor. Along the way, Carrel also reminds us that while a fund's returns can't be known ahead of time, its costs can—so focusing on cutting those costs can save you thousands of dollars down the road.

Rounding out this detailed discussion of ETFs are two chapters dedicated to building your own ETF portfolio, touching on everything from the mechanics of trading to designing asset allocation strategies. Here, Carrel calls upon a select group of financial professionals to help you understand a wide variety of portfolio construction possibilities and implement the ones that best suit your investment style.

The basic challenge that every investor faces is creating a broadly diversified portfolio for the least amount of money. ETFs can help you achieve this goal, and ETFs for the Long Run will show you exactly how.