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Why Exchange Traded Funds Had Such an Outstanding Run in 2016

Terry Mullen
Jan 9, 2017

The investor march away from individual stocks and actively managed stock mutual funds continues unabated, and the 2016 performance of exchange traded funds is just the latest reason why. While actively managed mutual funds still hold a significant share of the market, that share continues to shrink. There has already been a great deal of erosion, as investors abandon stock pickers and choose to invest in the market as a whole.

While the wisdom of investing in exchange traded funds (ETFs) depends on the year and the overall state of the stock market, ETF investors were handsomely rewarded in 2016. In the year just past, the returns for ETF investors were nothing short of outstanding, and there are some reasons why these passive investments were so successful.

The strong performance of the stock market was certainly one reason why exchange-traded funds had such a great 2016. Since exchange-traded funds like SPY and VTI invest in the Standard & Poors 500 and the total stock market, respectively, they reflected the impressive numbers their benchmarks were able to achieve as 2016 wound to a close.

While many political analysis, and some financial experts, predicted stock market Armageddon in the unlikely event of a Donald Trump victory, the results of the most recent election turned out to be a boon for stock market investors in general and ETF owners in particular. While it defied conventional wisdom, the so-called Trump bump was welcome news for stock market investors, and a real boon to holders of exchange traded funds.

New Records in the Old Year

During the last weeks of 2016 alone, the Standard & Poors 500, Dow Jones Industrial Average and NASDAQ all experienced nearly daily record highs, with each new record driving the value of ETFs higher and higher. While the market did not cross the technically meaningless but personally significant 20,000 threshold, the Dow Jones did get tantalizingly close.

The record high levels of the stock market as a whole helped drive up the value of exchange-traded funds, giving ETF investors one more reason to celebrate. While only time will tell if 2017 will see a repeat of the 2016 performance, there is certainly reason to be optimistic. 

The strong stock market performance in 2016 is just one reason ETF investors were so amply rewarded in the year just past. There are many other reasons why exchange traded funds, index mutual funds and other passive investments outperformed in 2016.

Lower Expenses = Higher Investor Returns

One of the most significant, but often overlooked, reasons for the outperformance of ETF investors lies in the lower fee structure of these passive investments. While the average actively managed mutual fund charges a management fee of 1% or more, some exchange traded funds incur expenses of just .05 to .10. That is a significant difference and one more reason ETF investors enjoyed such a stellar 2016.

While a less than one percent difference in investment expenses may not seem like much, the impact of those lower management fees builds up over time. Saving just one percent a year can boost performance by 10 percent over a decade, and by as much as 30 percent over a 30-year investing career.

Other Factors in ETF Outperformance

There are still more reasons why ETF investors continued to succeed in a big way during the year just past. While slow growth and low interest rates are still the norm, the overall economy continued to pick up steam during the 2016 calendar year. Perhaps most significantly, unemployment rates continued to fall in 2016, with more unemployed workers finding jobs and more publicly-traded companies increasing their future hiring plans.

That increased economic growth helped to fuel a wave of corporate investments, raising stock prices and increasing investor confidence in the process. As 2016 came to an end, a growing number of business owners expressed confidence in the economy and its prospects, and that confidence helped to fuel even more investment. Since ETF investors benefit from movements in the market as a whole, they benefited in a big way from that boost in investor and corporate confidence.

Quantifying a Great Year for ETF Investors

While many exchange traded funds enjoyed exceptional performance and stellar returns in 2016, the best performers were the ones that focused on the United States and its economy. Even as the United States stock market and the economy continued to outperform, many worldwide and international funds had a much less impressive year. These things tend to run in cycles, so it is entirely possible the script will flip in future years. For 2016, however, the United States stock market was clearly the place to be.

Consider the performance of VTI for example. VTI is one of the most popular, and one of the most widely held, exchange-traded funds on the market today. This Vanguard fund had a truly outstanding 2016, with total returns exceeding 10%1. That far exceeds the long-term average for the stock market, giving ETF investors one more reason to smile. 

Exchange traded funds that focused on small-cap stocks had an even better 2016, with returns in excess of 20%. Small caps outperformed in a big way during 2016, as business owners continued to invest in the growth of their operations and double down on their efforts to capture market share and maximize shareholder value.

Only time will tell what the future holds for exchange traded funds and the investors who favor them, but one thing is clear. ETF investors had a great 2016, with high returns, low costs, and exceptional performance. As the old year comes to an end and word spreads of this outperformance, more investors are likely to jump on the ETF train. 

Financial advisors, wealth managers, and other professionals were already seeing a shift away from actively managed funds and toward ETFs and other passive investments. Now that the 2016 stock market fund is in the record books, investors, and the financial professionals who guide them, are already looking forward to 2017 and what it may hold.


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