With ETFs, slow and steady wins the race

Oct 25th, 2019 | By | Category: ETF and Index News

By Rich Powers, Head of ETF Product Management at Vanguard.

Rich Powers, Head of ETF Product Management in Vanguard’s Portfolio Review Department.

Rich Powers, Head of ETF Product Management at Vanguard.

I was driving to work the other day when a beautiful black sports car zipped by at about 80 mph (in a 55 mph zone). A few miles down the road, I stopped at a traffic light, glanced over, and saw that same car pulling up right next to me. All that speeding and there we were, waiting at the same red light.

My conclusion? You can take it slow and steady or try to speed past everyone to get somewhere faster—risking a ticket, an accident, or possibly worse. You can drive really fast, but should you? It might not be worth it.

Since I’m immersed in ETFs every day as the head of ETF Product Management for Vanguard, I thought about how I could apply this lesson to answer a question I hear all the time: “Aren’t ETFs only for frequent traders?” Well … no, they’re not.

ETFs and individual stocks and bonds all have one thing in common: You can use any of them to try cashing in on market movements hour by hour. But maybe you shouldn’t.

ETFs and the myth of market-timing

It’s not hard to see why there’s a myth that ETFs are only for market-timers. Maybe it’s because the “mechanics” behind ETF trading make them appear as if they’re specifically designed for frequent traders.

  • Like individual stocks, ETFs are priced and can be traded minute to minute throughout the day. Mutual funds, on the other hand, are priced once at the end of the day.
  • Also like individual stocks, ETFs let you choose your order type (market, limit, stop, and stop-limit) and order timing (good for one day only or good till canceled). These options don’t apply to mutual funds.
  • ETFs aren’t subject to the same frequent-trading policies as mutual funds. Mutual funds are subject to certain trading limits, and some may impose purchase and redemption fees to help manage the flow of money into and out of the funds. ETFs don’t.

Remember that speeding car? The same lesson applies with ETFs: Just because they may seem designed to trade more frequently doesn’t mean they should be. So don’t be tempted to let that mindset affect your investing behavior.

The dos and don’ts of buying and selling ETFs

There are times when adjusting your investment strategy makes perfect sense. Just do it wisely.

For example, certain types of routine money movements can significantly affect your long-term success. Automatic investments make it easier to “set and forget” your savings strategy. Automatic withdrawals can help ensure you’ll meet IRA minimum distribution requirements after you turn 70½. (Unfortunately, automation isn’t widely available with ETFs yet. So for the time being, you’ll have to place each trade yourself or pay someone to do it for you.)

And I can’t understate the importance of portfolio rebalancing to keep your asset allocation on course. A whopping 90% of your investing experience—that is, the gains and losses you encounter and the returns you earn—is tied to your asset allocation. (Target-date mutual funds rebalance automatically. ETFs and other mutual funds require a bit more attention—you either have to rebalance yourself or pay someone to do it for you.)

What lands firmly in the “don’t” category? Trying to time the markets to chase short-term performance, which can be costly and rarely pays off.

Buy-and-hold investors can benefit from ETFs too!

I may sound like a broken record, but I wholeheartedly believe this: ETFs aren’t just for frequent traders. They can be equally suitable for buy-and-hold investors.

Just like index mutual funds, ETFs offer diversification, tax efficiency, and professional management—because most ETFs are indexed too. If you’re looking to keep things simple, you can build a complete portfolio with just four Vanguard total market ETFs.

Need a few more reasons?

How about lower trading costs? All ETFs are commission-free in a Vanguard account. Learn more about other conditions & costs that may apply

And you can get started with ETFs for the price of one share—usually about $50 to a few hundred dollars. You’ll need $3,000 to get started with most mutual funds. Even if that’s not a big deal for you, it could be for someone you’re helping to get started investing.

And sometimes ETFs have lower expense ratios—savings that can add up over time when you buy and hold.

Once an active trader, always an active trader?

As mentioned earlier, trading costs can add up—fast. With every trade, you have to cover the ETF bid-ask spread as well as the commission unless you enjoy commission-free trades.

More importantly, don’t forget about capital gains. In addition to the capital gains an ETF can generate by itself, the more you trade, the more you may be subject to higher short-term capital gains tax rates. Buying and holding investments aligned to an appropriate asset allocation may help you enjoy long-term performance without paying extra taxes.

You can’t grow money you don’t save

Reaching your financial goals rarely happens overnight. Regularly adding to your investments—even if you start small—puts the power of compounding to work for you. Just remember to focus on your asset allocation and rebalance about once a year.

These strategies might not sound as alluring (or as fast) as a shiny black sports car, but they could get you to the same place a bit more safely.

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)

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