ETFs Not Just For Riverboat Gamblers
Andrew Leckey

One might suspect that riverboat gamblers would favor exchange-traded funds as their investment of choice.

If they felt lucky about gold, for example, they'd be enjoying the 29 percent gain that the SPDR Gold Shares (GLD) ETF has provided over the past 12 months.

If they bet heavily on the allure of faraway places, it would've netted them a 22 percent increase from Vanguard MSCI Emerging Markets ETF (VWO) in that same one-year period.

The problem is that most investors are not eager to gamble with their assets. Thoughts of ETFs invested in commodities, single countries, single currencies, emerging markets, biotechnology or alternative energy are not necessarily comforting to the average investor.

Screaming headlines about dramatic gains and losses in highly focused ETFs have heightened the impression that only the brave of heart can consider these upstart vehicles.

The reality is that there are plenty of grown-up ETF choices for conservative investors, and the majority of invested ETF money isn't in the most exotic choices anyway.

"Be mindful that, compared with five or 10 years ago, there are much sharper tools on the ETF landscape today," said Anthony Rochte, senior managing director for State Street Global Advisors in Boston. "ETFs are simply indexed portfolios, and with about $1 trillion invested in them, there is no shortage to choose from."

ETFs hold baskets of stocks, bonds or commodities and are traded throughout the day on an exchange like stocks, rather than once a day like mutual funds. Average folks give ETFs a try because of some advantages over mutual funds like lower expense ratios and no year-end capital gains tax bills.

While the image of ETFs is a little on the wild side, you can still construct a conservative portfolio around them.

"The fact is that there really isn't a mutual fund that touches commodities like ETFs do," acknowledged Ron DeLegge, editor of ETFguide.com in San Diego. "But a conservative investor should have the broadest exposure to the widest asset classes on the planet, which is also possible."

Rochte and DeLegge both mention SPDR S&P Dividend ETF (SDY), a product of State Street Global Advisors, as an example of an ETF suitable for conservative investors. Its 14 percent increase over the past 12 months isn't as eye-popping as some volatile sector ETFs' gains, but it emphasizes value-oriented, high-yield stocks that over time should have greater capital appreciation than investment-grade bonds with similar yields.

This fund screens the S&P 1500 Composite Index for companies that have consistently increased dividends the past 25 years, then weights them by dividend yield. Nearly one-third of its 60-stock portfolio is in consumer goods stocks, with other concentrations in financial services, utilities and industrial materials. The biggest stock holdings in its portfolio are CenturyLink Inc., Pitney Bowes Inc., Leggett & Platt Inc., HCP Inc. and Consolidated Edison Inc.

Dividend hunting is an important tool for conservative investors. In ETFs, as in mutual funds, one can emphasize widely diversified large-cap value and blue-chip stocks or widely diversified bonds, said Paul Justice, director of ETF research for Morningstar Inc. in Chicago.

"You can build an entire conservative portfolio with ETFs through the largest providers such as Vanguard, iShares and State Street," said Justice. "You can also build an entirely diversified equity portfolio and cover the whole globe."

For U.S. equities, Justice recommends Vanguard Mega Cap 300 Index ETF (MGC) for the biggest stocks, Vanguard Mid-Cap ETF (VO) for mid-caps and Vanguard Small Cap ETF (VB) for small-caps. The easiest way to get exposure to all stocks domestically and internationally is through an ETF such as Vanguard Total World Stock Index ETF (VT). All of these have low expense ratios.

Yet ETFs aren't perfect for everything.

"If you are making frequent contributions and perhaps are in a tax-deferred account, a mutual fund makes more sense than an ETF (which incurs commission charges with each trade) because it was structured to maximize that experience," explained Justice. "Mutual funds are also the way to go if you're seeking active fund management, since most ETFs are index funds."

There are about 6,700 mutual funds and 1,200 ETFs, noted Justice, but ETFs cover many more types of asset classes than do mutual funds. These unique vehicles are on the rise: Three years ago there were only about 700 ETFs, he said.

Bond ETFs track major fixed-income indexes through a representative sample, whether that's Treasuries, corporate bonds or municipal bonds. They are a good location for some assets in the short-term because of liquidity and low cost.

Short-term fixed-income ETFs, such as the SPDR Barclays Capital 1-3 month T-Bill ETF (BIL), have gained popularity as investors seek safety. While this provides quick access to the Treasury market and the ability to get out on any day that the stock market is trading, the yield is currently near zero.

Vanguard Intermediate-Term Bond ETF (BIV), which holds government and corporate bonds with average credit quality of "A" and an average duration of six years, has a one-year return of 7.5 percent. The iShares Barclays Aggregate Bond Fund (AGG), which holds government and government-sponsored bonds with an average quality of "A" and a duration of about 4.5 years, has a one-year return of 5 percent.

These are not your riverboat gambler's ETFs.

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