Investment advisor Rick Ferri is virtually synonymous with ETFs. After all, the Troy, Mich.-based principal of Portfolio Solutions is a fixture at ETF conferences across the country, as well as author of The ETF Book, among others.
So when I sought him out in search of wisdom about which best-in-class ETFs he purchases for clients, I expected a long dissertation about the different ways to construct indexes and lots of financial jargon. But his response was refreshingly brief and simple: "The cheapest one," he said.
For your basic S&P 500 fund, Ferri would recommend iShares S&P 500 index (IVV), with an expense ratio is just 9 basis points. While State Street's SPDR S&P 500 (SPY) has the same expense ratio, its investment structure is less advantageous, he says.
As a unit investment trust, SPY reinvests company dividends once a quarter, whereas IVV has a mutual fund structure. "They can reinvest dividends as soon as the companies pay them. So if you're looking for the performance of IVV vs. SPY in an up-market, IVV is going to outperform. In a down market, it'll be the other way around," he says.
And what about equal-weighted or fundamental indexes from companies such as Rydex or PowerShares?
Ferri doesn't buy the "hype" that these funds outperform. In fact, he doesn't think they represent an apples-to-apples comparison. An equal-weighted S&P 500 fund, he argues, is actually a mid-cap fund — not a large-cap like the more traditional S&P 500 funds.
Their equal weighting essentially "takes a lot of money out of the larger stocks and pushes that money down into the mid-cap and small-cap stocks," he says. The traditional fund has an average market-cap of about $40 billion compared to a $12 billion average market-cap for an equal weighted fund.
"That's a completely different animal," says Ferri. "You can get the same thing by buying a mid-cap fund. There are a lot of ways to skin a cat."
And as a professional cheapskate, his preferred way is to avoid costly large-cap and mid-cap funds altogether — in favor of the Vanguard Total Stock Market ETF (VTI), which has an expense ratio of just 7 basis points. He then adds other portfolio elements until the desired asset allocation and average market-cap is achieved.
"This [VTI] gives you exposure to almost 4,000 stocks. So you now own the market and you can add elements to tilt the portfolio."
To bring down the market-cap and add a value bias, Ferri uses the Bridgeway Ultra-Small Company Market (BRSIX) and the iShares S&P SmallCap 600 Value Index (IJS).
