ETF Cost Beating Investment Strategy

in Finance & Business/Personal Finance by

The Issue

The primary issue with ETFs (exchange-traded funds), much like mutual funds, is the cost of operation. Thus, single shares in conglomerates are a much more effective personal investment strategy.

Normal ETF’s have 2 fees: the cost of the trade and the cost of management.

This can add up considerably, especially over the course of, say 40 years, a lifetime of investing. Should $10,000 be invested at the normal return of 7%, it yields $149,744. If ETF fees are taken into account, investing the same amount would yield only $124,160. Thus, ETF management fees would make a $25,000 difference.

Superior Investment Strategy

Wouldn’t it then make more sense to buy a single stock?

Yes and no. To own an ETF is to have a strong, diversified holding without having to develop and maintain one’s own portfolio. Yet, there is something better.

There are many companies that are heavily diversified in their own holdings. Companies such as Berkshire Hathaway and General Electric are like this. In example, Berkshire Hathaway owns the following companies (1):

  • American Express
  • Apple
  • Coke
  • Goldman Sachs
  • Kraft Heinz
  • Phillips 66
  • 21st Century Fox
  • US Bank
  • Procter And Gamble
  • Visa
  • Verizon
  • Walmart

Difficulties arise in trying to find other companies with an equal level of diversity to Berkshire, but, there are options. Some companies, such as Google, Amazon, Foxconn, Procter and Gamble, and GE, have highly diverse holdings and are expanding into many different sectors, making them appear to be valuable long term holdings.

Despite that Google and others are attractive to investors, the goal is to find companies that are so diverse that they are “too big to fail” in the long run. Financial institutions are a good place to look, having given loans to and invested in every sector. A Forbes investigation discovered the following.

The real power to control the world lies with four companies: McGraw-Hill, which owns Standard & Poor’s; Northwestern Mutual, which owns Russell Investments, the index arm of which runs the benchmark Russell 1,000 and Russell 3,000; CME Group which owns 90% of Dow Jones Indexes; and Barclay’s, which took over Lehman Brothers and its Lehman Aggregate Bond Index, the dominant world bond fund index. Together, these four firms dominate the world of indexing. And in turn, that means they hold real sway over the world’s money.

To control the way people see the markets is to control everything. These companies have that power, and as a result, are the top picks for long term investment, though Berkshire Hathaway may also be recommended due to the strength in its holdings and Buffett’s twist of Graham’s classic investment strategy.

The Exception:

The previous investment strategy was useful, but must be compared by individual to leveraged ETFs. If the fund is highly leveraged, it then becomes possible to expect returns that outweigh market return.

However, an advisory must be declared regarding the risk increase. For example, in 2009, geared ETFs focused in financials lost 90% in several months (2).

For this reason, if using leveraged ETFs, it is advisable to use highly diversified ones, like leveraged index funds. SPXL fits this bill. If one that is better is found, it will update.

To Conclude

The heightened risk still does not, in most cases, justify the increased returns. Instead of ETFs, individual stocks in diverse companies will save money and secure individual voting rights not guaranteed while using such funds.

Works Cited:

  1. Berkshire’s SEC Filings
  2. The sector lost 50% or .5 while levered 3 times, so the loss sustained equaled {[1-(.5^3)]*100} or 87.5%.
  3. http://www.forbes.com/sites/brendancoffey/2011/10/26/the-four-companies-that-control-the-147-companies-that-own-everything/#55155aa37f3b

 

 

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