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As mentioned in my last article, we’ve added some ETFs (exchange-traded funds) to most of our portfolio allocations. ETFs have been around for many years and are one of the more liquid, efficient and transparent investment vehicles available. They are similar to mutual funds in that they are professionally managed and provide investors with a diversified portfolio of stocks, bonds, etc., depending on the fund’s objective. However, there are some significant differences between the two investment types:

ETFs trade on an exchange throughout the trading day, like stocks, while mutual funds trade only at the end of the day at the net asset value (NAV) share price. Because they are traded on an exchange, investors are buying and selling with other investors, and not the fund itself.

ETFs can be more tax-efficient because they create and redeem shares with in-kind transactions that are not considered sales. Thus, taxable events are not triggered. Mutual fund redemptions can sometimes cause taxable events to shareholders if securities must be sold to meet the requests. This isn’t to say that ETFs will never produce taxable events for shareholders, but capital gain distributions are drastically reduced due to their structure. Dividends must still be distributed to ETF shareholders.

Most ETFs track to a particular index and are considered passively managed. However, two of the three ETFs we’ve chosen are fundamentally weighted stock ETFs, which are significantly different than the typical market-cap weighted, passive ETFs available. In my next article I will explain in detail the fundamentally weighted methodology.

Overall, ETFs are a small percentage of our allocations. We’re using them as a complement to our traditional active managers in some of the more efficient markets, such as U.S. large-cap stocks and foreign developed country stocks. Active fund management remains at the core of our investment philosophy. The addition of ETFs will help us round out our equity allocations in efficient markets and introduce more tax efficiency into the portfolios.

Mike Minter

As Chief Investment Officer, Mike directs the overall investment strategy, develops portfolio allocations, oversees trading and rebalancing, and conducts research and analysis. As a perpetual student of investing and the markets, Mike considers himself obsessed with the subject. He has earned the CERTIFIED FINANCIAL PLANNER™ (CFP®) and Certified Fund Specialist® designations. He is also an active member of the Houston chapter of the Financial Planning Association (FPA).   Read Mike’s Profile HereRead More Articles by Mike

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