This $2 Trillion Market Is Just Getting Started


They say making your first trillion is the hardest.

Exchange-traded funds can certainly relate. After taking almost two decades to go from zero to $1 trillion in assets under management in ETFs, new figures from BlackRock -- arguably the biggest beneficiary of the ETF trend -- show that the ETF universe has now eclipsed the $2 trillion mark just four years later.

But despite the amazing past growth of ETFs, all signs point to even further gains in assets for the foreseeable future. Although that's an encouraging trend in many respects, there are still some reasons for investors to remain cautious. I'll discuss those concerns later in this article, but first, let's look at what has pushed ETF assets into the stratosphere and why that move is likely to continue.

Giving investors what they want
When the first ETFs became available in the U.S. in the early 1990s, they were simple index-tracking funds, largely mimicking traditional index mutual funds that accomplished many of the same purposes. Yet while index mutual funds owned the same stocks in the same proportions as their ETF counterparts, what ETFs offered was the ability to trade those fund shares in real time on stock exchanges, rather than having to wait until the end of the day to buy or sell. If you've ever seen stocks fall sharply in the last hour of the market day, then you can related to the value of being able to pick exactly when you decide to execute your trade.

Since then, ETFs have mostly kept their index-tracking strategies. Although the PIMCO Total Return Bond ETF has awakened interest in actively managed ETFs, most have still stuck to the industry's passive investing roots. But the sheer mass of indexes for which ETFs are available has exploded in size, with the number of new indexes to track growing almost as quickly as the number of new funds that follow them. Moreover, with a much wider set of asset classes, it's easy for investors to rotate from one sector, investing style, or geographical exposure to another at will.

So what's the problem?
Until the past several years, costs were one reason that ETFs were problematic for some investors. Because you have to pay commissions to buy ETF shares, those who were used to making small automatic purchases of fund shares once or twice a month faced the prospect of much higher transaction costs. Yet in response, numerous brokers, including Schwab , TD AMERITRADE , Vanguard, and Fidelity, now offer commission-free ETF purchases and sales to their clients. That removes the disincentive to using ETFs in automatic-investing strategies and makes them viable long-term options for ordinary investors.

The danger with ETFs, though, is that their ease of use can tempt you to use them in ways that are contrary to sound long-term investing strategies. Like owning a sports car that maxes out at 150 in a state with 55-mph speed limits, having the ability to trade ETFs whenever the market is open can lead you toward short-term trading strategies that use that ability -- even if it's not to your long-term benefit.

In addition, you need to be sensitive to annual management fees even for index-tracking ETFs. Some of the smaller niche products in the industry come with relatively high fees of close to 1% or even more. By contrast, industry leaders BlackRock, State Street , and Vanguard have been engaged in a price war of sorts with their respective ETF offerings, with many funds having seen expense-ratio reductions recently.

Stick with ETFs
With well over 1,000 different ETFs to choose from, not every ETF is right for your portfolio. But all those choices give you the ability to find the perfect ETF for you -- and will make it much easier to invest without letting Wall Street grab more of your money than it deserves.

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Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter @DanCaplinger. The Motley Fool recommends BlackRock and TD Ameritrade. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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