The NYT is discussing the various benefits of ETFs in “The Low-Cost Power of Exchange Traded Funds.” One section caught my attention, which I like to hone in on and that’s the tax advantages of ETFs over mutual funds:

There is another cost advantage to E.T.F.’s that leads analysts to predict continuing expansion: taxation is less severe.

“An E.T.F. is almost like having money in a retirement account.”

Of course, keep in mind that if an ETF pays any kind of dividend, that will be subject to taxation in a taxable account.

What the above article references are the year-end distributions (capital gains and a losses) that mutual fund companies are required to pass on to the investors whether the fund has made money or not. That’s where ETFs have a huge advantage in being able to avoid this issue.

If the tax aspects of investing via a taxable brokerage account are important to you, ETFs definitely have the edge over mutual funds.

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

The bulls remained the upper hand, and the major indexes closed higher again.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has now crossed its trend line (red) to the upside by +5.29% keeping the current buy signal intact. The effective date was June 3, 2009.



The international index has now broken above its long-term trend line by +6.20%. A Buy signal was triggered effective May 11, 2009. We are holding our positions subject to a trailing stop loss.




[Click on charts to enlarge]

For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.

The WSJ reports that newly designed ETFs are supposed to fix some of the shortcomings of traditional bond funds. Here are some highlights from “New ETFs Look to Fix Drawbacks of Bond Funds:”

A new batch of exchange-traded funds aim to address a traditional shortcoming of bond funds: the lack of a fixed maturity. But part of the price is increased complexity.

There are other quirks as well, and almost inevitably new funds develop unforeseen issues. But in an industry too willing to cater to fast money or rely on gimmicks, these funds bear watching as a potentially attractive option.

[Emphasis added]

This appears to be a very intriguing concept, which attempts to bridge the gap between buying bonds outright and bond funds with their lack of a fixed maturity.

If the above issues/quirks can be addressed, and these ETFs can be purchased/sold at lower costs than outright bonds, along with moderate ongoing expense ratios, this could be a worthwhile consideration for those investors looking to generate a reliable income stream.

Let’s listen in to some highlights of “ETF Study: The Long-Term Costs of High Fees:”

A key advantage to exchange traded funds (ETFs) is their ultra-low expense ratios (on average) compared to the expense ratios of mutual funds. Although the expense ratio is only one factor to consider, studies show that over long periods of time, it can save or cost you vast sums of money.

Granted, the situation is highly theoretical since it is unrealistic to assume that both portfolios would perform identically. But the example shows the strength of compounding interest, even with small percentage differences, over a long period of time.

Sure, the generally lower expense level of ETFs can have a positive outcome when looking at the long-term effects of compounding. However, there are a few other thoughts to consider.

If you are simply buying and holding, as opposed to tracking trends, these alleged savings can and will be eaten up next time a bear market strikes such as we’ve seen in 2000 and 2008. To my way of thinking, it’s more important to focus on an investment strategy, such as trend tracking, that prevents participation in severe market drops, which can save your portfolio from a serious decline as opposed to saving a few dollars in annual fees.

I have found that only looking at expense ratios to make a mutual fund/ETF selection does not tell the whole story. I remember the rebound from the bear market in 2003 during which one of our mutual fund holdings rallied some 60% in 90 days.

Do you think it mattered to me that they had one of the highest expense ratios in the industry? Of course not, because it’s not a matter of what something costs but what it will do for you. That is one of the most often overlooked factors in the race and sometimes misplaced focus of finding nothing but the lowest price.

That’s why in my selection process of ETFs/mutual funds for trend tracking, momentum ranks way above expense ratios, because that’s the ingredient which will provide us with potential capital gains. If low costs happen to be part of my selection, then I will take that as a bonus but not as a criterion.

Smartphone sales have been on a tear ever since Apple introduced the iPhone. With many competitors now offering similar products, demand seems to be rising as Tom at ETF Trends points out in “Accessing Smartphone Popularity With ETFs.”

Let’s take a look at MTK, an ETF that not only covers the major players but also some of the cellular service providers. Here’s a 2 year chart:

The long term trend has been clearly up, but more importantly for the use of trend tracking, the pullbacks have been modest. During several corrections in the past year, MTK came off its high by only -8.84% (I refer to this as MaxDD%), which happened on 1/29/10. If you used my recommended 10% sell stop for sector funds, you would have not been stopped out.

Before you get all excited and jump in, there are a couple of shortcomings you should be aware of. First, average daily volume is only $1.7 million dollars. But if you have a modest amount to deploy in this arena, this should not present a problem. Second, I checked, and the bid/ask spread is a hefty 4 cents.

That is a little pricey; however, if this ETF continues on a hot streak, it could be well worth your consideration.

Disclosure: We have no positions in MTK.

In regards to the topic of diversification, reader Wayne had this to say:

I have $40,000 invested in 10 different funds. I read in one of your articles that I only need to be in 2 funds with that amount invested. Should I just pick 2 index funds from your recommended list? How do I diversify into stocks, bonds, international and domestic?

To my way of thinking, before you can discuss diversification, you need to first decide on which investment strategy you are employing.

For example, if you are simply buying and holding, you need to have a different fund selection approach as opposed to trend tracking.

With B&H; you are always exposed to market risk with no safety net in place. That makes it imperative that you own funds/ETFs in your portfolio that (hopefully) will zig when the market zags. Traditionally, this task of neutralizing, when equities head south, has fallen on the bond portion, which in the 2008 debacle did not turn out as planned.

If your mode of operation is trend tracking along with the use of trailing sell stops, then you can go for growth, if that’s what your objective is, without having to worry about a bond portion to bail you out.

Not knowing your circumstances, I can’t comment specifically. However, I have clients with portfolio sizes similar to yours that are invested in 3-4 ETFs covering a broad spectrum, which have produced good returns.

So yes, for a $40k portfolio, you can use 3-4 ETFs, or index funds, and cover just about most of the investment arenas that are worthwhile to be exposed to.