ETFs for Retirement

Since their inception in the early 1990s, the number of exchange-traded funds (ETFs) has grown tremendously. A broad array of ETFs are now available, specializing in broad underlying investments from equities to currencies, so it is no surprise ETFs have become popular with retail investors.

ETFs are often convenient and cost efficient—enabling retail investors to gain market exposure without purchasing individual securities. ETFs can also help you diversify your portfolio holdings.

ETFs generally offer more liquidity than mutual funds, since their shares can be bought and sold throughout the trading day, like shares of individual stocks. For these reasons, investing in ETFs for retirement may seem like a viable option, particularly for investors with smaller portfolios. But if you have larger amounts to invest, we believe there are some good reasons why other options may do a better job of helping to meet your long-term investing goals.

What Are ETFs?

Exchange traded funds are similar to mutual funds in that they both pool money from many investors to purchase a diversified portfolio of stocks, bonds or other securities. Many ETFs seek to mirror the performance of a particular index, sector or asset class. For example, some ETFs are designed to move in sync with the S&P 500 index, while others track sectors such as energy or real estate, or asset classes such as small cap stocks or intermediate term bonds. Investors with smaller portfolios may be able to achieve some level of diversification by purchasing a number of different ETFs—which may help save the transaction costs associated with buying minimal amounts of several stocks or bonds.

The relative affordability of ETFs can be attractive, since you won’t pay the transaction costs associated with buying minimal amounts of several stocks or bonds. Owning and trading ETFs also tends to cost far less than mutual funds because ETFs usually don’t charge the sales loads and other fees that mutual funds generally do. However, costs can vary widely from one ETF to another.

Many ETFs are also liquid and easy to trade. Their shares can be traded throughout the day, the same way you trade stocks, whereas mutual funds settle at the end of each trading day. If you have access to the stock market, most ETFs are easy to buy and sell. In fact, ETFs are so easy to trade that many investors find it difficult to resist the temptation to do just that—and often make hasty trading decisions fueled by emotion instead of sticking to a long-term investing plan.

Generally speaking, it is possible to create a diversified retirement portfolio using ETFs, and also to modify your allocations quickly, at a relatively reasonable cost. But if you are an investor with a larger portfolio, it’s wise to take a closer look before you assume that buying ETFs is the best way to diversify your holdings.

The Pitfalls

Like any investment, there are pros and cons to holding ETFs as part of your retirement portfolio. We’ve already outlined the benefits above, so now let’s consider the limitations, which include:

  • Lack of personalization: Simply put: ETFs are not designed for you specifically. If you have unique needs or desires—for instance, the desire to restrict a certain company or type of companies—that can be difficult with ETFs. If you fit into the high net worth category and have a large amount to invest, you will likely be better off having a customized portfolio that is tailored to suit your preferences and is designed to achieve your individual financial goals.
  • Tax disadvantage:* Minimizing capital gains tax liability is important for high net worth investors. While ETFs may be more tax efficient than mutual funds, owning individual stocks and securities can help high net worth investors benefit from practices such as tax loss harvesting to a greater degree than ETFs allow. For instance, let’s consider a hypothetical ETF that had a net return of zero in a given year. This ETF has two securities: one experienced significant gains during the year while the other experienced significant losses. While investors may not be able to harvest tax losses from owning the ETF, if they own the underlying securities they may be able harvest tax losses from the security that fell significantly.
  • Less cost efficient: Despite index ETFs’ low cost, they can actually end up being more expensive investments than mutual funds. This is because the underlying assets comprising an index ETF may have to change more frequently to accurately mirror the index they track. Frequent trades of large blocks of stock generate high turnover costs—which are, of course, paid by the ETFs’ shareholders. If you own a portfolio valued at more than $500,000, even a fraction of a percentage more could end up costing you quite a bit—much more than the cost to an investor with a small portfolio, relative to portfolio size.
  • Over diversification: Diversification is generally a good thing, but only up to a point. If you invest in several ETFs and do not keep a close eye on their underlying assets, you asset allocation strategy can easily be derailed without your realizing it. The assets in two ETFs you own may replicate or overlap each other. The same could also be true regarding mutual funds or other investments you own. Too much overlap could lead to overconcentration in specific equities, sectors or asset classes. This can undermine your carefully constructed asset allocation strategy. To diversify a retirement portfolio, we believe it is necessary to know and understand that each of its components is working together to meet your long-term objectives.
  • Detraction from long-term financial goals: Intraday liquidity can be a good thing in markets, but there is a downside. As already noted, the ease of trading an asset too often can result in investors making trading decisions based on emotion, such as selling during a routine market correction, then missing the bounce upwards that often follows shortly after. This can be counter to an investor’s long-term financial goals. We believe high net worth investors generally do better to maintain their long-term investment objectives and hold assets they’ve chosen to fit their asset allocation strategy.

A Better Approach

With all the available ETF and mutual fund choices, analyzing whether it’s good to choose ETFs for retirement savings can be a daunting task. This becomes more important as your portfolio grows.

If you have a portfolio of $500,000 or more and want a comfortable retirement, we believe you may benefit more from working with an investment adviser who knows your goals and preferences, and is charged with looking after your best interests.

Fisher Investments is happy to provide portfolio reviews to qualified investors with $500,000 in investable assets. We can look at the mutual funds and ETFs you hold and identify overlaps in underlying assets. We can also determine whether you might benefit from direct investments.

Investors who become our clients receive specific asset allocation and investment recommendations aligned with their personalized financial goals and world-class client service from our dedicated Investment Counselors.

For more information, request an appointment or learn more about Fisher Investments through one of our many guides.

* The contents of this document shouldn’t be construed as tax advice. Please contact your tax professional.

Investing in securities involves a risk of loss. Past performance is never a guarantee of future returns.
Investing in foreign stock markets involves additional risks, such as the risk of currency fluctuations.