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Monday, December 28, 2009

Investing: ETFs or Mutual Funds?

The mutual fund industry is going to be overwhelmed by ETFs. An Exchange Traded

Fund trades like a stock, the same commission as a stock, you can buy or sell an
ETF during the day like a stock and does carry not the big management fee of a
mutual fund. So why buy a Mutual Fund? Some may argue better performance, but its
usually not so. Do a little homework and compare. Ask your advisor how much he
makes from the sale of the mutual fund to you. Then ask him to justify it by
comparing the recommended mutual funds to several similar ETFs. Maybe some mutual
funds are better...but the vast majority underperform.

Here is an example of an ETF: XME, one I've held in my IRA most of this year and
have traded in my active taxable account.
http://finance.yahoo.com/q?s=xme.
This link takes you Yahoo Finance and provides more details than I'll show here.
XME is up over 65% this year, including the March collapse time period!

Here is the profile of XME: "The investment seeks to replicate as closely as

possible, before expenses, the performance of an index derived from the metals and
mining segment of a U.S. total market composite index. The fund uses a passive
management strategy designed to track the total return performance of the S&P
Metals & Mining Select Industry index. The index represents the metals and mining
sub-industry portion of the S&P TMI. The fund is nondiversified." Passive indexing
is the key to LOW expenses, FAR lower than any and all mutual funds. And did I
mention you can buy and sell it any day, any time of the day, any day of the week?
Many mutual funds are like CDs many banks issue, penalty for withdrawing,
restricitions on when you can withdraw yada yada. ETFs, you buy, you sell...when
you want...that's called liquidity and is its most important aspect as I'll
explain later. ETS have tax advantages as well.

Back to XME: its a minerals, metals and mining index "fund" in the form of a stock
(known as an "ETF"). So its a stock with a basket of these companies (and more)
which are the top 10 holdings comprising half of the "fund":

TOP 10 HOLDINGS ( 48.67% OF TOTAL ASSETS)

Company Symbol % Assets

ALCOA INC AA 4.48

ALPHA NATURAL RES ANR 4.55
ARCH COAL INC ACI 5.3
CLIFFS NATURAL CLF 5.51
COEUR D ALENE CP NEW CDE 4.49
COMPASS MINERALS INT CMP 4.99
CONS ENERGY INC CNX 4.85
FREEPORT MCMORAN B FCX 4.89
MASSEY ENERGY CO MEE 4.55
PEABODY ENERGY CORP BTU 5.06

Its 67% "industrial materials" and mining stocks and 24% "energy" stocks.
Minerals, metals and energy are what companies use to build the world. When
industrials are humming, these are consumed in large amounts. That is what is
happening in the world, today. Even after a world wide financial meltdown...XME
(metals, minerals and energy) has hugely "outpefomed".

Here are its results for 2009: TRAILING RETURNS (%) VS. CATEGORY

Return XME (Mkt) XME (NAV) Category* Index*

Year To Date 65.91% 65.26% 53.97% 24.07%

So, while the S&P 500 (SPX), the 500 largest US companies are up 24.86%, this
cyclical ETF is up more than twice. A good one to have owned, and far better than
most mutual funds. And a good one to own going forward.

This is a link for ETF education : http://finance.yahoo.com/etf/education. There

is a wealth of basic information in plain English in easy Q&A format...which does
not diminish but rather enhances with clear and concise explanation what ETFs are
and how they work for you.

The most important reason for me to own an ETF is that YOU decide when its
working, when its stocks are working, when its not and when to own it or not. Not
only is it easier and cheaper to buy and sell than a mutual fund, it can be sold
and you can go to CASH when or if the market melts down. You might think, well,
we'll never have another financial meltdown like the last one. That's what we
thought in October, 1987, what we thought after the tech bubble was burst in 2000,
that's what we thought after "9/11". If on "9/11" or on the multiple days between
October, 2008 and March, 2009 when the market collapsed more than 10% on a given
day or consecutive days...you could not sell your mutual fund on that day. But
with an ETF, and a "stop loss market" order...you could have set a stop order on
all or a portion of your ETF and your account would have automatically sold your
ETF, when that order price was hit. If you bought at $30 and decided to lose only
$1/share...then your sale would have been triggered when the price hit $29 an your
loss limited to that $1, or close to that. But if your money was in a mutual
fund...your order to sell may not have been executed until the close of business
the NEXT day in many instances. That's "liquidity"...you can sell, when you want,
or when you need to. The worst part is, you can't expect the funds manager to
protect you if you hold. They RIDE the stocks down...right to the bottom. They
don't go to CASH, like you can. So, you get comfortable with this genius
manager...but he just holds. For most, their prospectus and by-laws require they
remain fully invested at all times and limited to a certain % of cash, often no
more than 5%. So, you ride it down too...there are no stop loss orders on mutual
funds. I for one, will NEVER ride a fund to oblivion.

In another article, we will discuss why CASH is KING. Many of the huge downdrafts
can be avoide by just standing aside until the carnage has passed. But if you just
bought and held mutual funds, you probably have about half of what you had 2 years
ago...and would have almost exactly the same sum you had 10 YEARS ago. But if you
eased out of the market and back in, when dangerous and safe...your performance
would not represent what some call the "lost decade" in the US stock markets.
Easing in and out will the subject of a seperate article as well.
Posted by Don't Take Losses at 10:55 PM