Debunking 7 Myths of ETF Investing
Myth 1: The best ETFs to own are the Dow DIAMONDS (DIA), PowerShares QQQ Trust (QQQQ), and the SPDRs (SPY)
The best ETFs to own are the ones that help you to reach your own unique financial goals. And just because a certain ETF is popular, heavily advertised, or widely followed, doesn’t necessarily make it better versus other ETFs or an appropriate choice for you.
Instead of focusing on one or two individual funds, try building a portfolio of ETFs that offer broad exposure to key asset classes like stocks, bonds, commodities, and real estate.
Myth 2: ETFs are more risky than mutual funds.
ETFs, like mutual funds, come in a variety of shapes and sizes. The level of risk in an ETF or mutual fund is often determined by the portfolio holdings within the fund.Some indexes, industry sectors, or markets will be more risky or volatile than others. However, there’s no substantiated investment research to prove that all ETFs are any more or less risky compared to mutual funds.
Myth 3: ETFs are only for day traders and short-term investors.
The truth is that ETFs are effective portfolio building tools for all types of investors.
While ETFs are often used by active investors as trading vehicles, they can be effectively used by buy-and-hold or long-term investors. Whereas one investor may purchase a particular ETF to hedge, another may purchase the exact same ETF with a completely different strategy, perhaps to grow capital. The unique product design of ETFs allows investors with both similar and dissimilar investment objectives to own the same fund and still accomplish their goal.
Myth 4: The performance of individual stocks and mutual funds is better than ETFs.
Like mutual funds and stocks, ETFs can track a variety of markets. In any given year, some stocks and funds may actually outperform certain ETFs, whereas during other time periods they’ll under perform.
The economy, inflation, interest rates, and market conditions are a few factors that will impact performance. No one knows with any certainty which stocks, mutual funds, or ETFs will perform the best in the future.
Myth 5: ETFs are the same as individual stocks.
Even though ETFs are traded on major stock exchanges along side individual stocks, they are not the same. Rather, ETFs consist of an underlying portfolio of securities that’s designed to follow a specific index or investment strategy.
ETFs are typically more diversified than individual stocks.
Myth 6: Actively managed or fundamentally weighted ETFs are better than market cap weighted ETFs.
Even though fund marketers may present financial data that shows actively managed or fundamentally weighted ETFs outperforming traditional market cap weighted index ETFs, the numbers are hypothetical. Supposing that alternatively weighted indexes hypothetically outperformed, it’s important to understand there’s no guarantee they will do so in the future.
Myth 7: ETFs are more expensive than mutual funds because you have to pay a brokerage commission to buy them.
Generally speaking, investors buying or selling ETFs will pay a brokerage commission whereas investors buying or selling no-load mutual funds pay none. However, some brokers impose a commission to buy or sell no-load mutual funds. Also, many mutual funds (even no-loads) impose back-end redemption charges for selling their funds before a restricted time period.
Any fair cost analysis between ETFs and mutual funds should look at the entire spectrum of expenses – not just the transaction fee to acquire the fund. Investors should pay attention to financial costs such as expense ratios, brokerage commissions associated with the fund’s internal portfolio turnover, and tax efficiency.