For the first time, individual investors have access to an international real estate (REIT) index fund in an exchange-traded fund (ETF). The StreetTracks Dow Jones Wilshire International Real Estate ETF began trading on the American Stock Exchange on December 19th, under the Ticker: RWX.
Details on the new ETF can be found on the StreetTracks Global Advisors website.
I am a huge fan of the new ETF fund structure for individual investors. They offer a very transparent, low cost method for any individual with a brokerage account to create a diversified portfolio. Unlike the various shell games that the mutual fund industry has generated over the years to hide the true expenses paid by individual investors, ETFs have very transparent expense ratios, and commissions for trading already reflect rock-bottom prices available at most brokerages.
ETFs are not perfect. If you want to put $100 away every month, a tradition no-load mutual fund is the right way to go. Otherwise, the brokerage commissions will kill you. But for larger accounts, or for investing lump sums, the cost structure of ETFs cannot be beat.
Let’s take an example from my favorite fund family, Vanguard. They offer a large family of no-load funds, and are famous for their low costs.
The Vanguard Total Stock Market Fund mirrors the entire universe of US Equities, the Wilshire 5000. According to the Vanguard website, the Investor shares that you would purchase have an expense ratio of only 0.19%. That’s fantastic compared to the average mutual fund, which charges over 1.0% typically for expenses. But the exact same fund in ETF form has an annual expense ratio of only 0.07%.
7 Basis Points. That’s it. For a fully diversified stock portfolio. $7 for every $10,000 invested.
Let’s take 3 proud fathers, each of which who wants to save $10,000 at the birth of their child for college 18 years out. Father 1 invests in a typical mutual fund. Father 2 invests in the Vanguard Total Stock Market investor shares. Father 3 invests in the ETF. Let’s assume, for this example, that all three return the exact same 11% annual return over 18 years.
At the end of 18 years, Father 1 ends up with $55,599.17 to pay for college. Not bad, not bad at all.
Father 2 fairs much better. Vanguard’s lower-than-average expenses net him $63,448.47. Yes, 0.81% of expenses per year matters to the tune of almost $8,000.
Father 3, with the ETF, gets a little bonus in his stocking. After 18 years, his account is worth $64,696.72. Almost $1250.00 extra.
Now, the sharp reader out there might be saying, “Adam, you forgot the fact that the mutual fund has no commision cost. What about the commissions for making the ETF trades?”
Assuming the $10 commission that E*Trade charges on the purchase and the sale, Father 3 ends up with $64,622.02. Still about $1,183 ahead of Father 2.
Low, transparent expenses are only one reason I like ETFs. The second is clear, transparent asset allocation.
There are now ETFs for everything. Until recently, if you wanted to own gold, you had two options: buy the yellow metal itself, and pay storage/security costs or buy a gold mining stock mutual fund. However now there is an ETF that just does one thing – it owns gold (Ticker: GLD)!
You might be wondering why this is on my mind lately. Well, two reasons.
Reason 1: It’s a new year, and one of the financial house keeping chores I like to do at the start of a new year is review finances, saving & investments, and make decisions for the new year. One of the most important financial chores in any financial plan is “re-balancing” your investments across different types of assets. Every year is different – some things do well, others do poorly. Once or twice a year, it’s a good idea to re-set your balance so that you don’t end up over-invested in the things that have recently gone up, and under-invested in the things that have recently gone down.
Reason 2: StreetTracks Dow Jones Wilshire International Real Estate ETF launched, filling a gap in most people’s asset allocation strategies.
Real Estate is an interesting asset class. REITs, as a whole, have been on a tear the last few years, so like every boom, the stocks have run up and the yields have gone down. Still, most analysts would agree that it’s a good idea to have a small portion of your long term savings in real estate.
No, owning your house does not count. Your house is more a residence than an investment anyway, and it’s far too undiversified, both in terms of sub-sector and location.
There have been real estate mutual funds for a long time, and REITs, as a corporate structure, became big in the 1990s as a way for the average investor to own a piece of a large, diversified real estate portfolio. However, for a long time, it has been hard for the average US investor to get international real estate exposure. There has been one or two mutual funds that focus on the area, but they are fairly high cost.
Enter our new friend: StreetTracks Dow Jones Wilshire International Real Estate ETF.
Now you have the ability to allocate a portion of your investment in real estate to the global market. The index isn’t perfect (this blogger, for example, seems to take issue with the geographic allocation and timing). Nonetheless, this is a great new option for individual investors to have, and in general, most US investors continue to be over-invested domestically, and under-invested globally.
There are also two strong contenders for domestic REIT ETFs to round out your real estate allocation:
Hopefully, this information will get you thinking about your own asset allocation, and the potential for ETFs as a vehicle for your own savings.
Enjoy!
Psychohistory 
Other potential downsides to ETFs (just for completeness sake), that potential investors should consider:
– Just like any stock, when buying or selling an ETF there is a bid/ask spread that may impact that real price you can buy or sell the fund for. So, if an identical mutual fund and ETF had an identical real-time price (let’s say, $x), the mutual fund could necessarily be bought for exactly $x, but the ETF would likely have a higher actual purchase price, due to the bid/ask spread. Likewise for the ETF sale. Generally, this spread is small (especially for ETFs which tend not to be as volatile as individual equities), but with large investments, the incremental loss due to spread can be non-trivial;
– Since ETFs are traded on the open exchange, you will often see situations where the ETF is trading at a discount or a premium to the actually value of the underlying investments (i.e., the price doesn’t necessarily track the NAV of the fund). As the market is pretty efficient, this discount/premium won’t generally be great, but again, when talking about small advantages/disadvantages compared to a mutual fund, these amounts may not be trivial, and shouldn’t be discounted in the analysis.
– Another issue that I’m not familiar with (but am very curious about) is how brokerages deal with dividends paid through ETFs. If they don’t reinvest the dividends (as mutual funds do), and the investor must pay additional commissions/fee to reinvest the dividends, this can have a tremendous impact on the long-term investment return of the instrument.
Of course, for more speculative investors, there are also additional benefits to ETFs:
– ETFs can be shorted ;
– ETFs can be bought on margin;
– ETFs can be traded throughout the day (as opposed to mutual funds that can only be purchased once/day, at the closing price of the fund).
Jason
Jason, these are all very good points.
The ETF structure, for the most part, allows the big guys to really take advantage of any inconsistency in valuation or bid/ask. That keeps the valuations pretty tight, although with new, small ETFs, that problem might become more relevant.
Reinvesting dividends is a brokerage issue. E*Trade will reinvest dividends in ETFs for free, no commission. They treat it like a DRIP program. I have the Vanguard Small Cap Index (VB) set up this way, and it works just like a no load fund, but it’s an ETF.
Thanks for reading! I continue to eagerly await the next post on The Steinhorn Stare…
Another important ETF Advantage – Capital Gains
-In taxable account, turnover in a fund leads to taxable gains (even in index funds, although turnover is small). This will add up in long run, especially for daddy 1 whose fund will presumably have reasonable turnover. You should do your own math, but for example, if 50% of fund turns over in a year, and average gain is 22% (11% * 2 year average hold) tax liability could lower returns by more than a couple % a year depending on your personal tax bracket. Not as extreme for index funds but still material. If you must have mutual funds, keep them out of taxable accounts and in a Roth or 401K.
Quick note on REITs-
Just a quick follow up, REITs have destroyed the market for 7 years running (by more than 6% annualized). Low correlation to homebuilding (or your house), valuations primarily driven by macro trends such as interest rates (as an investment REITs are dividend plays and are also typically leveraged at 40-60%), rent growth, occupancy, population trends etc… In fact, recent housing downturn increased rents -when people stopped buying and decided to rent- driving up the multyfamily sector. Major downside of REITs is current valuations are also being driven by record capital flows into market. PE shops like Blackstone buying up hotels and office (like recent $36 Billion EOP buyout) keep driving up prices and limiting available public equity. Although there is no end in site to current demand, valuations are at historically high AFFO multiples (a proxy for cash flow that REIT investors use). However, you could say the same thing last year before the REITs returned 36%….
Number 1 Says:
Thanks for reading, Number 2. I did not even try to incorporate tax issues into the example, but you are very correct about the high degree of mutual fund distributions.
Speaking of NAV and AFFO, how do you find them for lots of REITs (especially non-US) (or ETFs that invest in REITs), along with number of shares outstanding?
In regard to trade commissions, note that on Zecco, you get 40 trades per month free.