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ETFs: If You Don't Know About Them, You Should Take a Look

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Welcome to CNBC's ETF retirement portfolios.

I've brought in six of the best independent (not affiliated with any exchange-traded fund family) ETF experts to form an advisory council to build three retirement ETF portfolios: one for a 70-year-old, one for a 50-year-old and one for a 30-year-old. I've asked for a broad portfolio, including U.S. stocks (small and big cap, either in a blended fund or separately) and bonds (Treasurys, corporates, munis and TIPs, as appropriate, either in a blended fund or separately), and international stocks and bonds, as well as a small amount of commodities.

I've asked that the advisory council explain their choices for each portfolio; any additions or deletions should also be explained.

Why ETFs? One reason is diversification. Think about this: Before 2004, there was no way easy way to own gold. Sure, you could buy coins or open a futures trading account, but they were clumsy vehicles. The SPDR Gold Trust (GLD) changed all that.

You couldn't very easily own oil, either. Or natural gas. Or stocks in Tokyo. And certainly not Asian bond funds. Heavens.

Now you can ... using ETFs.

And the investing public has responded.

The ETF business has grown exponentially in the past decade. In 2002, when I first mentioned the funds, there was a mere $100 billion under management. By 2006, the amount was $400 billion. By 2009, it had doubled.

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Three years later, at the end of 2012, it hit $1.3 trillion, a 25 percent increase in one year.

And at the end of the first quarter of 2013, there's almost $1.5 trillion under management. And that's just in the U.S.

Those are small numbers compared with the roughly $13 trillion in stock and bond mutual funds, but ETFs are gaining fast, and the mutual fund industry is staring nervously over its shoulder. Some—like Vanguard Group—have long since joined the ETF ranks and offer a diverse portfolio of mutual funds (actively and passively managed) and ETFs.

Even more important, the ETF industry has attracted the biggest and best players. Players with deep pockets, particularly the ones at the very top. Three ETF providers—BlackRock/iShares, State Street and Vanguard—control more than 80 percent of the assets under management.

The remaining 20 percent fill different niches, from inverse/leveraged ETFs to exotic international instruments.

In addition to diversification, ETFs provide lower costs and better portfolio transparency, and are more tax efficient than most mutual funds. For active traders, the ability to trade during the day is the clincher.

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And there's another reason for the rising interest in ETFs. For most investors, indexing is the way to go. According to fund analyst Deborah Fuhr, 81.2 percent of active large-cap managers in 2011 didn't beat the S&P 500.

Think about that. Mutual fund investors sometimes pay exorbitant fees—usually one to two percent a year, sometimes more—for active management. And most do not outperform benchmark indexes.

No wonder many younger, innovative, cost-sensitive advisers have adopted ETF portfolios. Instead of charging one percent to two percent, financial advisers can charge, say, 0.5 percent or less, and put their clients in an internationally diversified portfolio.

Ah, but they are just tied to indexes, you say. So what? There are ETFs that now operate across all asset classes (stocks, bonds, commodities, real estate) and across dozens of countries.

And if you're waiting for low-cost, actively managed ETFs, you won't have to wait long. There are already several, but Fidelitywill very likely jump into this space in a big way this year.

My point: Financial advisers can now generate their own "alpha" (outperformance) by placing clients in the right funds.

Or you can do it yourself, generate your own "alpha." You can be an active manager using ETFs. Start by taking a look at our portfolios. Look at the reasons cited for buying the funds. And if you don't agree with the viewpoint, build your own portfolio.

I will have more to say about how to build a portfolio using ETFs in the next several weeks, but here's how to start: with a time frame and a viewpoint. You have to say, "I am creating a portfolio for (1, 5, 10, 20, 30 years ...) and right now I am bullish on bonds/bearish on stocks, or bullish on the U.S. economy/bearish on the global economy." Whatever. It all starts with a time frame and an attitude.

From there, it's a matter of choosing ETFs that match your investment philosophy. Most portfolios are built around "core" holdings, a few that represent the largest percentage of the assets. For U.S. stocks, many use the SPDR S&P 500 (SPY).

But where to go for information on ETFs? There are many websites, but if you're new to this, a simple, free and good site is finance.yahoo.com/etf. Here, you can get ETF news and research individual funds.

A more sophisticated site is indexuniverse.com, where you can run a much wider array of screens. Matt Hougan, who is on the advisory council, is president of ETF Analytics and the global head of editorial for IndexUniverse.

But don't drive yourself crazy—check out our ETF retirement portfolios!

By CNBC's Bob Pisani

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  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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