We are often times skeptical of some of the secondary effects of the ETF industry around here.  In part, that is due to the fact that ETFs have in many ways radically improved the investment landscape for individual investors.  Indeed we recently wrote that investors now have the tools necessary to customize their investment portfolios provided they “know what they are doing.”

That is why were interested when Matthew Hougan at IndexUniverse updated a post he had written a few years ago looking at the extent to which ETFs have driven down the costs of holding a broadly diversified ETF portfolio.  We have referred to this original post often on this blog, in part because it demonstrates just how dramatically ETFs have served to change the investment landscape.  Hougan notes how the cost of this globally diversified portfolio has dropped from some 16 bp down to 12.5 bp.

Nor does the above analysis take into account that many investors now have access to free ETF trades though their broker.  This may in fact have a bigger effect on costs that do the actual expense ratios.  The sum total of these two effects is to drive down the cost of holding plain vanilla index funds down toward zero.

Cost is not everything.  Dave Nadig also at IndexUniverse quibbles with some of Hougan’s fund selections.  He notes that there may very well be better fund alternatives, especially when you take into account trade frictions like bid-ask spread.  Nadig is also interested in moving beyond capitalization-weighted funds towards ones that use fundamental weightings.

Nadig’s points are well-taken.  However they do not detract from the overall message that ETFs are helping driving down investor costs.  This point is often obscured in the media of late.  The launch of the trendy, specialized, and usually high cost ETF is a far sexier story.  Then again, these funds are more often the source of investor disappointment as their complexity tends to offset their more straightforward sales pitch.

The ETF industry is, for now, a competitive one.  This competition works to both drive down the expense ratio of plain vanilla funds at the same time generating new, more specialized funds with higher expense ratios.  In a certain sense it is not unlike the typical supermarket.  The supermarket entices you in to purchase their loss-leaders, like milk, in the hope you will also purchase higher margin products, like packaged goods.  There is likely room in you portfolio (shopping cart) for both kinds of funds.  The question for investors is one of education and balance.

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