Recently, I received an e-mail concerning whether you should invest in ETFs or mutual funds in a Roth IRA account.
Here's the entire question:
Hi TJP, In your blog, “Investing in International REITs” (18-May-07), you
mentioned the DJ Wilshire Intl Real Estate (RWX) for quick international REIT diversification. According to your subsequent blog, you picked the Alpine International Real Estate Equity fund (EGLRX) for your Roth IRA. Why didn't you pick ETFs, such as RWX or the new DRW, for lower costs in a long term account, such as an Roth IRA? I am torn what to pick for my Roth for lower costs over time.
So how do we figure out which method of investing performs better? We calculate the numbers, and let math be the deciding factor!
Using my Fidelity Investments account (where I own my Roth IRA) as an example, I will backup my preference for actively managed mutual funds over passive ETFs when investing in the international real estate market. Of course, my reasoning may change in the future.
Your Choice – Lower fund expense ratios or 18 Years of International Real Estate Experience?
As the reader pointed out, I invest in Alpine's International Real Estate Fund (EGLRX) in my Roth IRA account instead of passive ETFs like SPDR DJ Wilshire Intl Real Estate (RWX) or WISDOMTREE INTL REAL ESTATE (DRW).
You are probably thinking that ETFs perform better over the long term due to their lower expense ratios. So let's compare the expense ratios of all 3 funds, then see how they would perform over the long run (assuming the fees remain the same).
|Fund Name||Expense Ratio||Manager Tenure/Fund Life||5-year Performance|
|Alpine International Real Estate Fund (EGLRX)||1.18%||18 yrs||27%|
|SPDR DJ Wilshire International Real Estate (RWX)||0.59%||6 Months||11.6% (LIFE)|
|Wisdom Tree International Real Estate Fund (DRW)||0.58%||1 month||-3% (LIFE)|
First off, the longevity of Alpine Investments Real Estate Fund & fund manager Samuel Lieber indicates a certain level of stability and safety when investing in EGLRX. I would never invest in any fund that has a fund life of 1 year of less. Investing in RWX or DRW requires an audacious step because we have very little past fund history to examine and research.
While you pay twice as much to invest in EGLRX, consider this opportunity cost because you gain access to a top notch fund manager with over 18 years of experience in international real estate.
Is 18 years of financial experience in international real estate worth an extra 0.6% in expenses per year?
To me, it's worth the extra cost since the fund needs to outperform the tracking ETFs by only 0.6% to make up the difference. EGLRX returned 16% over the past 10 years, crushing DJ Wilshire REIT index (its underlying index) by over 15%.
Comparing Fund Costs with Vanguard's Costs Tool
Let's see how much the extra costs will effect an initial $10,000 over the course of 20 years assuming a 10% annual return. Vanguard has a nifty fund costs tool that performs the job nicely.
|Fund Name||Expense Ratio||Investment Value Before Costs||Investment Value After Costs|
|Alpine International Real Estate Fund (EGLRX)||1.18%||$67,275.00||53,165.46|
|SPDR DJ Wilshire Intl Real Estate (RWX)||0.59%||$67,275.00||$59,766.14|
|Wisdom Tree International Real Estate Fund (DRW)||0.58%||$67,275.00||$59,886.49|
While ETFs appear to perform better over the long term, these numbers assume a few factors like:
- Apline Real Estate Fund will match the returns of RWX & DRW – Sam Lieber's fund could outperform the alternative ETFs in the long run. One reason is that Apline investors gain exposure solely to Sam Lieber's picks, however ETFs expose investors to the entire international real estate market. I don't want to own everything; I only want the good stuff.
- Fees do not increase between any of the 3 funds – An expense ratio increase could rain on all your long term investment plans.
- You never sell your ETFs – By selling your ETFs, you have to pay out a sales commission. Normally, investors can buy/sell mutual funds at no cost if you trade with a top notch broker.
Deciding between No Cost Mutual Fund Buys or Commission-based ETFs
All the data above assumes you pay zero commission fees, but the average broker charges commissions on Stocks/ETF trades. Unless you buy stocks for free, ETFs commissions will eat up a portion of your returns.
As for mutual fund trades, many brokers like Fidelity provide free trades when you setup an automatic account builder plan, but ETF trades cost $20 per transaction.
Other differences between ETFs and mutual funds include price sensitivity, tax implications, etc.
Investing is very personal in nature – there is no right answer
Being a college student, I have limited funds, and choose mutual funds over ETFs to avoid commission fees. My financial situation is probably different from yours, so your investment strategy will differ as well.
If you believe in strictly passive investing, then invest in exchange-traded funds instead. Just make sure you control unnecessary commission fees, and understand which investments your ETFs hold.
Now's your chance to share your insight on ETFs and mutual funds for long term retirement accounts.
Which do you primarily invest in – ETFs or mutual funds?