Grading The 25 Largest ETFs

Do your ETFs make the grade?

The 25 largest U.S.-listed ETFs have about $2.9 trillion in assets. They represent less than 1% of the 2,621 total U.S.-listed ETFs, but about 44% of the nearly $6.6 trillion in ETFs.

So, chances are, you own at least one or more of these. Let’s begin with the final grades and then I’ll explain my grading system.

Methodology

My grading system is simple: two grades (midterm and final) and one overall grade. I start by grading how diversified the fund is. Narrower funds present a couple of problems.

First, they tend to have higher standard deviations that mathematically result in a high probability of underperformance versus broader funds. Second, there is more performance-chasing, resulting in lower investor returns.

The next grade is on fees, and we all know higher fees result in lower returns. I compare the fees relative to alternative ETF choices in the same asset class, taking into account that international stock ETFs are more expensive than U.S. stock ETFs.

I place no weight on past performance. Also, note that my grading system is different than the established ETF.com Analytics grading system, which analyzes the ETF’s efficiency, tradability and fit, which are important factors. To see the single largest difference, the SPDR Gold Trust GLD aces the ETF.com Analytics system, as it does a great job of earning the return of gold, and is extremely liquid.

But mean old professor Roth flunks the SPDR Gold Trust (GLD), because it’s very undiversified, because owning the metals itself costs 0.40% less annually, and because it’s not a proper vehicle to own gold long term. Even my huge gold mistake was less costly than buying a gold ETF while paying fees over the past few decades.

Results

I grade these 25 ETFs from an A+ to an F.  With the exception of GLD, grades ranged from an A+ to a C-, so all other ETFs at least got a passing grade. Though it may seem like I’m an easy grader, think of this as an honors class. For the most part, these ETFs became the largest by being more diversified, with far lower fees than the average ETF. So an ETF like a triple levered inverse ETF never would have made this class.

Yet it’s also important to note that there are many ETFs not in the top 25 that would have also aced my grading system. For example, the iShares Core S&P Total U.S. Stock Market ETF (ITOT) would have received the same A+ as the Vanguard Total Stock Market ETF (VTI), as it has nearly as many holdings and the same expense ratio.

In addition, there are times when a narrower ETF is warranted.  My first index funds back in the 1980s were S&P 500 index funds, as they were the first ones launched when John Bogle changed the investing world.

These funds represent roughly 80% of the U.S. stock market. So I own an extended market index fund that is a completion fund owning the other 20% of the U.S. stock market. Buying small and midcap ETFs doesn’t complete the total stock market.

Finally, I’m not above having a little fun. I recently purchased an ultra narrow and pricey ETF, but that was for gambling rather than investing.

Admittedly, grading is almost always subjective, so you may strongly disagree. But before complaining, at least take a look at the following rationale for each ETF.

Investing is all about “minimizing expenses and emotions; maximizing diversification and discipline.”

Stick with the ETFs that minimize fees and maximize diversification. Doing so will serve you far better than going with past performance or your gut feeling about which parts of the market will outperform.

Allan Roth is the founder of Wealth Logic LLC, an hourly based financial planning firm. He is required by law to note that his columns are not meant as specific investment advice. Roth also writes for the Wall Street Journal, AARP and Financial Planning magazine. You can reach him at [email protected], or follow him on Twitter at Allan Roth (@Dull_Investing) · Twitter.