ETF investing gaining traction with advisors and investors

I read a recent survey by the Financial Planning Association that revealed some interesting statistics about how financial advisors are using exchange-traded funds in their client portfolios.

The 2014 Trends in Investing Survey showed that 79 percent of advisors now use or recommend ETFs with clients, up from just 40 percent in 2006. And 39 percent of financial planners indicated that they plan to increase their use of ETFs over the next 12 months—the highest anticipated increase among 17 investment vehicles.

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So what's behind the increasing interest in ETFs?

First of all, an ETF is a security that tracks an index, commodity or basket of assets, like an index fund, but trades like a stock on an exchange. ETFs experience price changes throughout the day as they are bought and sold.

ETFs have really come into maturity over the last 10 years. In the beginning, ETFs were very basic and used primarily by institutional investors.

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However, as more individual investors were able to access financial information online or sought advice from a financial advisor, the popularity and market for ETFs exploded.

I decided to do my own mini survey to find out why several of my colleagues find ETFs appealing and why they are increasingly including them in their clients' portfolios.

Most of the advisors I spoke with cited transparency, passive management and low cost as advantages of ETFs. I have to agree, as these are the primary reasons we use them at our own firm.

But while these are attractive qualities, they're not unique to ETFs. Many mutual funds have the same characteristics. They are also transparent, passively managed, tax efficient and have lower costs. For the most part, we're fairly agnostic as to whether we use a mutual fund or an ETF as a solution.

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Some advisors like that, as with stocks, ETFs trade "intraday"—i.e., within one day's trading session, during regular business hours. For us, the benefit of being able to trade intraday is not that important.

Where this does make sense is if an advisor wants to use ETFs for sector rotation strategies while keeping their costs low. They might own a real estate index, then sell it when it reaches a certain level and move into consumer staples, then rotate it into energy. With ETFs, they can also set price targets for upper and lower limits (limit orders). This is something you cannot do with a mutual fund.

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As transparent as some ETFs claim to be, I do worry about niche ETFs when firms our size are placing big trades.

A few years ago we wanted exposure to a currency-hedged foreign index fund, and over time we slowly put dollars into this ETF. When we realized that our position made up too much of the fund, we weren't comfortable and slowly moved out of it. Our concern was that if the ETF was thinly traded, we might, in fact, move the needle when we sold. Advisors should not only examine the ETF's size but also how thinly traded it may be.

"Today, when we look at the universe of options, one or more of those solutions is fulfilled by ETFs."

Like most advisors, we examine many solutions for our portfolios.Today, when we look at the universe of options, one or more of those solutions is fulfilled by ETFs. Currently, we're using ETFs within certain indexes, such as large-cap and master-limited partnerships.

What really excites us is the next generation of ETFs, especially in fixed income. We're starting to see defined maturity ETFs, and if they offer a low-cost solution that brings diversity in a fixed-income ETF, that would be very attractive for our clients.

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I believe that what we've seen is just the beginning. As this plays out, the barrier to entry for mutual funds and ETFs keeps getting lower and we're getting more and better choices.

Like my fellow financial advisors, I'm looking forward to having additional tools and more solutions to build our clients' portfolios.

—By Barry Glassman, Special to Glassman is founder and president of Glassman Wealth Services.