SAN DIEGO (ETFguide.com) - It’s not hard to be confused by
the rapid ascent of the exchange-traded fund (ETF) marketplace. In just one year
the number of funds has shot from 267 to well over 500.
All of
this has set off a wave of controversy, debate, and criticism about the state of
the ETF marketplace. Iconic figures such as John Bogle, Warren Buffett, and
William Bernstein have expressed their cynicism about ETFs. Other naysayers
abound, and a loud coalition of those with an anti-ETF bias are making their way
into the media.
Many
important questions are raised: Have ETFs become a speculative mania? Do ETFs
induce investors to self-destruct? Is there an ETF bubble?
Curiously,
a basic understanding of ETFs eludes even those at the highest levels of
contemporary finance. As a result, people are led to draw wrong conclusions.
Arming and
defending yourself against ETF fiction is a definite must. If you don’t, making
prudent and wise investment decisions will be near impossible.
Here’s a
brief sample of the financial fiction that’s floating around:
FICTION
#1 - ETFs encourage investors to become hyperactive traders
Intraday
liquidity is an important product feature of ETFs. It gives investors a flexible
exit strategy by allowing them to buy and sell shares when the financial markets
are open for business.
Interestingly, individual stocks also have intraday trading just like ETFs.
Should we make the case that stocks should be completely avoided because they
trade daily and might induce investors to needlessly trade? Making a similar
claim against ETFs is irrational and misleading.
The fact
is many investors with chronic behavioral problems were that way long before
ETFs arrived on the investment scene. Dumping on ETFs is misplacing the blame.
Should we fault automobiles for car accidents? How about blaming fire for
burning people? Knives for cutting people? Likewise, saying that ETFs induce
investors to self-destruct is absurd.
FICTION
#2 - ETFs are a bad choice because of the growing number of poor ETF investment
options
One gander
at the mutual fund marketplace reveals a true lesson in financial clutter.
Counting the maze of share classes, there are over 20,000 mutual funds to choose
from. How about the 9,000 or so hedge funds? By comparison, right now there's
roughly 530 ETFs.
Even
though the ETF market is headed for the same overcrowded destiny as the others,
the clutter is arguably worse elsewhere. Instead of proving that all ETFs are
bad, it proves that investors need to be discriminatingly selective.
Favoring
funds based upon traditional indexes with rock bottom costs and having a
long-term outlook never hurt anyone. This is exactly the sort of high value
proposition many ETF families offer for anyone smart enough to notice.
FICTION
#3 - The ETF industry markets and sells ETFs the wrong way, therefore ETFs are
bad
It’s
unreasonable to judge the investment merit of ETFs by the marketing behavior of
fund companies. ETFs should be evaluated by the underlying securities they hold
and the investment strategy they follow.
If the ETF
industry wants to ape the mutual fund industry by mislabeling funds and
launching new products with questionable investment merit, so be it. However,
broad generalizations and sweeping statements that paint the entire ETF market
as “good” or “bad” is unfair and counterproductive.
I wish I
could say my list of financial fiction was exhaustive, but it’s not.
In
summary, ignore the trumpet blows from those that demonize, mischaracterize, and
stereotype ETFs.
The
growing number of ETF choices calls for diligent evaluation and discriminating
selectivity.
