For good reason, ETFs continue their popularity increase

Some recent press reports highlighted the large outflows from mutual funds. In the five weeks that roughly corresponded with October, according to the Investment Company Institute (ICI), $20.4 billion was removed from U.S. stock mutual funds.  According to ICI  data, in the related 12 months period (ending November. 2, 2011), investors removed $124.3 billion from mutual funds that invest long-term in domestic stocks.

The ICI data is roughly consistent with similar data prepared by Morningstar. According to Morningstar, U.S. stocks mutual fund investors redeemed $18.2 billion during October.  This was described as “the greatest monthly outflow for the asset class since $22.7 billion in July’’.

The incorrect conclusion drawn by some about this short and long-term data is that retail investors are fleeing from stocks. Investors may be fleeing from mutual funds that invest in U.S. stocks, but that does not mean they’re fleeing U.S. stocks. During October, the Dow Jones Industrial Average went up around 12.5%, and the NASDAQ went up around 11%. If investors were fleeing stocks, how could these indexes have performed so well during October?

Instead of departing stocks, capital is flowing into a different type of fund – exchange-traded funds (ETFs). According to statistics compiled by the New York Stock Exchange, $61.8 billion went into ETFs during October. ETFs are quite similar to mutual funds in that they hold a variety of underlying securities, but ETFs are purchased and sold through a brokerage firm just like an individual company stock. Most ETFs track an index, such as the S&P 500 or MSCI EAFE.

ETFs can be attractive as investments because of their stock-like features. ETFs can be bought or sold at any time, just like shares in a single company. In contrast, shares in mutual funds only get valued, bought and sold overnight, in between trading sessions. ETFs typically have lower costs and greater tax efficiency than mutual funds.

Our article Investing Made Easy provides additional information regarding asset allocations, and how ETFs can be used. We provide specific recommendations of low-cost, passive-investing ETFs.


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