Why ETFs Suck

By Carlos Portocarrero on 8 June 2010 (Updated 11 June 2010) 33 comments
Photo: rednuht

UPDATE: After reviewing all of the comments and thinking about this long and hard, I've published a counter article that sheds light on the positives of ETFs. Please check it out to get a more balanced view of what they are and what they can do. Also check out Xin Lu's article on ETFs.

ETFs burst onto the scene a few years ago and have gotten more and more popular. They have a very specific purpose, but most investors are better off staying away from them, and I'm going to show you why.

What Is an ETF?

ETF stands for exchange-traded fund and it's basically a glorified mutual fund that represents an index or collection of stocks. So what's the difference between an ETF and a mutual fund? Well, an ETF looks more like a stock: you can trade it like a stock since its price changes throughout the day.

Who Cares?

Traders, that's who. Everyday people like you and me who are used to putting our money into mutual funds should simply disregard ETFs. They don't apply to us and despite what everyone says, they won't give you any advantage when making investment decisions.

Why They Suck

ETFs suck for a very simple reason: everyone is talking about them and are all excited by them (even I was an early convert), but no one is saying that only a very tiny slice of the population can truly benefit from ETFs.

Traders use them to trade in an out of indices like the S&P 500, commodities like gold and oil, and currencies like the Euro. They also use them to short these specific markets. Traders trade and that means buying and selling a lot throughout the day to make money.

The rest of us aren't doing this. We're investing for the long terms so we can retire without having to move in with our kids and totally cramp their style. Using ETFs in your retirement account is a monumental mistake.

Top Things I Hate About ETFs:

  • Fees: With mutual funds you pay an annual expense ratio but with ETFs you pay a fee every time you buy some of it, just like a stock. These fees pile up pretty quick.
  • Hype: Because they're new and few people have taken the time to think through the down side, most investors just buy into the hype instead of thinking critically about how these work and if they're a good fit for them.
  • Traders: If traders are using them, then I don't want any part of them. Nothing against traders, but they go in and out of their holdings so fast that you'll eventually get left in the dust. Not ideal.

ETFs aren't evil, they're just not for the masses. Stick to good ol' fashioned mutual funds and index funds unless you want to play ball with the traders.

God help you.

Tagged: Investment, ETFs
1.933335
Average: 1.9 (15 votes)
Your rating: None
ShareThis

comments

33 discussions

Add New Comment

CAPTCHA
This test helps prevent automated spam submissions.
Guest's picture
IndyJCL

With Vanguard i can buy ETFs with no trading fee. As a dedicated index investing devotee (Boglehead!), they are now very attractive to me because (at least the vanguard ones) they duplicate Vanguard index funds at half the fund cost. I have no desire to trade my account.

Guest's picture
Steve

Overall, a good post. That said, just because traders use something doesn't make it bad.

Also, mutual funds are the work of the devil:

http://www.sanfranmag.com/story/best-investment-advice-youll-never-get

That article is a good read, but it's a bit lengthy. The summary: shift out of mutual funds today, and into index funds with Vanguard (in the US) or TD Bank (in Canada).

Which index funds? That's where the next two links come in.

http://www.moneysense.ca/2006/04/05/couch-potato-portfolio-introduction/
http://www.milliondollarjourney.com/tax-optimizing-the-couch-potato-port...
With these two pages, you can set up a tax-efficient portfolio that beats 80% of the mutual funds out there. Higher return, less risk, lower fees, and it only takes fifteen minutes.

Seriously folks, do this.

Guest's picture
Dangerman

This article really misses the point: the Fees can be far -LESS- with ETFs than with mutual funds. Lots of places allow $0 trades on certain ETFs (as mentioned, Vanguard, as well as Fidelity).

Since the expense ratio on ETFs is almost always less than the comparable mutual fund, buy-and-hold investors get a better deal over the long run.

Guest's picture
Guest

Wow, most undereducated article I have read in a long time! There are many Mutual Funds that have associated trading costs and many ETF's that don't. ETF's also on average have lower expense ratio's and greater tax efficiency for buy and hold investors. They are certainly exceptions (Leveraged ETF's come to mind). Just because everyone is doing it doesn't make it bad (think owning a checking account). And avoiding buying things that traders buy will lead to a very short list of investment options (those mutual funds own stocks and traders buy those). Wisebread should filter out junk like this it is an article that will likely do more to hurt those that read it than help. Spreading misinformation is never a good thing and in this case I would call it morally objectionable. Please have someone who knows what their talking about edit this article before you do damage.

Guest's picture
twblues

This article is based on bad logic. If ETFs are good for A, they can't be good for B. WTF? Tain't necessarily so.

Guest's picture
Kathryn

Note to self: don't take financial advice from someone who uses the word "suck"

Carlos Portocarrero's picture

Couple of things here: I’m not implying that anything a trader does is “bad.” But a trader’s needs and the average investor’s needs are very different. VERY different. I can’t stress that point enough.

I looked at the Vanguard ETFs and sure enough, the expense ratios are lower than their already super-low index funds (which I love). And you’re right, some places will let you trade ETFs without paying a commission. But there is some fine print: with Vanguard you need to have at least $50,000 in your account. Otherwise you’ll pay a $20 annual fee. So that needs to be calculated in there too.

In all, ETFs aren’t “evil” or anything, I just think that too much is being made of them. The ones that are actually useful to the average investor are glorified index funds. And the biggest selling point that gets touted again and again—that they trade like stocks and the price changes throughout the day—is meaningless for average investors investing in the long term.

One more thing: suck.

Guest's picture
Dangerman

"...glorified index funds..."

This was the whole reason behind the invention of ETFs.

"the biggest selling point that gets touted again and again—that they trade like stocks..."

Not from what I read. As mentioned, the HUGE advantages of ETFs (over the long run) are low cost and tax efficiency. Try reading more Bogleheads, and less SeekingAlpha. You're replying to people who are already known to be wrong, and ignoring the reasons why ETFs are actually great.

Guest's picture
Steve

I was on the fence, but this sensationalist and misinformed article has pushed me over the edge to unsubscribe from the Wise Bread feed. Please do research before spouting off, there are many who are not as savvy and will buy into this blatantly incorrect information.

Guest's picture
Heather

This article is definitely based on faulty logic. I understand your suspicion of ETFs, but you have to consider that the mutual fund industry has been ripping off unsuspecting Americans for DECADES with high fees, poor performance (most actively managed mutual funds underperform their benchmarks) and a lack of transparency.

Just because ETFs are used by traders does not make them in and of themselves bad. In fact, many pensions (Harvard, for one), investment advisors, retirees and other people who wouldn't necessarily be "traders" use ETFs, and they do so wisely. Yes, the intraday liquidity of ETFs make them easier for traders to jump in and out of, but that doesn't mean that that's their only application. Far from it.

Furthermore, as others have mentioned, online brokerages are offering amazingly good pricing thanks to increasing competition. Vanguard has the lowest fees in the industry and recently lowered prices on their brokerage platform. Schwab has free trading on their line of core ETFs and lowered commissions on all others. Fidelity has free trading on 25 core iShares ETFs. Yes, you have to trade smartly. You have to keep commissions in mind. But I would gather that most investors at home are not doing rapid-fire trading. They're buying ETFs and holding them in long-term accounts or buying them, watching and selling when the trend peters out weeks, months or years later.

Traders also give many ETFs their superior liquidity and help keep the spreads tight, so I wouldn't knock them too hard. They provide a service to investors at home. But you're right - it's foolish to try to keep up with them.

ETFs don't suck - they're a major innovation that have changed the way Americans invest and it's given the power of decision-making back to them, thanks to transparency, liquidity, lower cost and a range of core and niche options. Mutual funds are a rip-off, and I'm glad more people are finally realizing it. If the high fees were returned by market outperformance, that would be one thing. But that's not happening. Mutual funds are money down the drain.

Carlos Portocarrero's picture

I agree about mutual funds—I am a full-fledged supporter of index funds over mutual funds. Not just for myself but for the average investor.

I should’ve chosen my words wisely. The goal of the article was to bring ETFs back down to earth and offer a little perspective. I know a lot of people that have heard all the ETF buzz and jumped right in (and not into the cheaper Vanguard or Fidelity versions, but the ones that cost as much as a stock to buy and sell) without really giving it much thought.

That was the goal and I let my sensationalist title get the better of me. I really hope the commenter who said they were unsubscribing isn’t going to let one tiny dissenting voice ruin all the great information on the site.

Guest's picture
Darren

I agree that ETFs are not necessary for most buy and hold investors who now have their money in index funds.

However, as WC Porter hinted in his comment, Vanguard ETFs can be attractive because of their lower expense ratios and lack of commissions. But this is only if you have over $50,000 to invest.

When I get to that point, I'll reconsider ETFs. Until then, I'm sticking with mutual funds.

Xin Lu's picture
Xin Lu

Sorry WC, but this was a bizarre article...if you hate traders, then why did you recommend buying GS in a previous article?

Carlos Portocarrero's picture

I most definitely don't hate traders! But their needs are so fundamentally different from the needs of most of us, that it irks me when a product that seems tailored for one group is adopted by another.

It's like if my mother-in-law bought herself an Apple Powerbook with 6GB or RAM because that's a really good machine. But it's overkill for her, you know what I mean?

Guest's picture
Chris

This doesn't make any sense at all.

If you look at fees alone, ETF's have an advantage over indexed mutual funds. I'm not sure what the story is in the US, but in Canada there are companies that allow you to do DRIP's and PACC's (Pre-Authorized Cash Contribution) which bypass trading fees (perfect for long term investing). When you get into a couple hundred thousand dollars, this difference in fees is big money.

The fact that they trade like a fund is an advantage to "normal" people as well. I can set limit and stop orders. When I sell I get my money faster. With high liquidity there's more certainty in the price I'm getting.

"Traders" jumping in and out should have no effect on the performance of the ETF as a whole, it's just a transparent index of stocks (or bonds or whatever).

The more I think of it, this is a ridiculous article. ETFs aren't even that new anymore, why are you trying to stir up ****?

Guest's picture
Dave

The author really did not make his case at all and was not very convincing. I am quite happy with the ETFs that I have purchased (without commission) through Vanguard and Wells Fargo. The only "trading" that I have done is the initial purchase and some year-end tax-loss harvesting.

Xin Lu's picture
Xin Lu

Also, WC, you have to understand that traders affect mutual funds, too, since they trade all the stocks underlying the funds. Large ETFs track the indices very well in real time, and I don't see that as a bad thing. In case of a catastrophic crash you would probably want to liquidate before the market hits zero.

Guest's picture
Koko

I would strongly disagree.
One of the most important thing an ETF has and Mutual Fund doesn't is the option to purchase , well - options !
For example, you can buy an ETF and easily hedge using put options.
Options are important hedging strategy of every balanced portfolio, and are relevant even for non-professional investors, like most of us.

Xin Lu's picture
Xin Lu

yup,not all ETFs have options, but the large ones like SPY does and in volatile markets like this that's trending down it is worthwhile to have some cheap options as insurance. You can also sell covered options on your ETFs as an income strategy, and that's a good thing.

Carlos Portocarrero's picture

I've been thinking about this post and all the feedback all day and I feel an apology is in order. After going through all the comments, doing some extra research, and talking to some people, it's pretty clear my post has some significant holes in it.

For that I apologize to Wisebread readers. You all deserve better than that. I will come back and post again on ETFs and try to do as much as I can to rectify this post.

Hopefully the comments will give readers some knowledge and this post will wind up doing some good after all.

Sorry everyone!

Xin Lu's picture
Xin Lu

Unfortunately most people don't read the comments. I look forward to your follow up article.

Xin Lu's picture
Xin Lu

Since I can't reply to a reply in this, I'll respond to WC's comment where he wrote

"I most definitely don't hate traders! But their needs are so fundamentally different from the needs of most of us, that it irks me when a product that seems tailored for one group is adopted by another.

It's like if my mother-in-law bought herself an Apple Powerbook with 6GB or RAM because that's a really good machine. But it's overkill for her, you know what I mean?
"

Personally I don't feel like traders' needs are fundamentally different than normal investors'. Normal investors want to make money, and so do traders. Normal investors want to have liquidity in their investments, and so do traders. ETFs are definitely NOT just designed for traders and if you dug a little deeper you'll see that traders that trade ETFs do not affect the ETFs' value much because index ETFs mostly track the indices very well, but the traders that trade the underlying stocks do affect the values. However, mutual funds' values fluctuate due to the underlying stocks, too, so if you want nothing to do with traders then I would suggest selling all your mutual funds holding stocks & bonds.

Guest's picture

With all due respect, this article indicates a major lack of understanding of what ETFs are, and how they can be used.

Bottom line is that there are many different types of ETFs that can be used different ways by different people. They are a very useful financial tool.

Guest's picture
Guest

I have been a long term individual investor for 22 years and have read thousands of articles on investing.

This is THE most uninformed, dramatic, factless, inaccurate and misleading article that I have ever read on investing.

It has brought down my general impression of wisebread in a very large way - if the owners of this site allow this type of article then I wonder about all the other articles on the site.

Xin Lu's picture
Xin Lu

Dear guest,

I hope you continue to read Wise Bread and see if WC writes a more informed followup post.

Guest's picture
Guest

This article was certainly a "what the heck?" moment for Wisebread followers. Apology is accepted but really the extent of the illogic makes it pretty embarrassing. Whether you're a trader or an investor, everyone is looking to make a profit in the most time and cost-efficient (including taxes) way. If you're investing and you like the price/value of the underlying securities in an ETF, then buying and holding makes perfect sense.

Guest's picture
jim

Honestly I'm not even clear on what "traders" is supposed to mean. Trader is such a generic term. Are you talking day traders? Anyone who buys/sells stocks? Nefarious wall street firms who manipulate markets and steal candy from children? Who are these traders and why the distrust over what they do?

Carlos Portocarrero's picture

My correction post has been submitted and will hopefully be up soon.

I do want to add one thing on what I mean when I say "traders."

I work with traders. I have nothing against traders. But they have completely different outlooks. Yes, we're all trying to make money. But traders want to make money on a daily basis. By trading.

I'm assuming most Wisebread readers are investors. Buy and hold (at least for more than a week!).

It's not that I distrust what traders do or what they stand for, it's just that it isn't anything "we" should be trying to emulate.

We aren't traders, we're investors!

Guest's picture
Christopher MacPhail

This article is full of bad reasoning and bad advice. Many ETF's have lower ongoing management fees/expenses than most mutual funds. The buy/sell commission of maybe $5 to $10 is high if you're buying $500 worth at a time. But I don't think that's "most people." If you're a buy and hold person, and buy in chunks greater than $1000 the lower expense loads far outweigh the commissions.

Stay away from ETF's because they're popular and icky people partake? Well then, you better stay off the internet and stop using currency also.

Guest's picture
Guest

I might unsubscribe to this website after reading this article.

Carlos Portocarrero's picture

Here we go: here is the new article I posted to help balance this one out. And also check out Xin Lu's post on commission-free ETFs. Hopefully these two articles well help counter some of the bombastic claims in this one.

Guest's picture
Guest

WC Porter, you should be quite proud. (Proud of your humility... ? Ha, that's ironic).

But in all sincerity, I wouldn't want anyone investing my money or giving me financial advice if they couldn't show the strength of character I see here, on display now.

Your two articles have given me a good balance of understanding ETF's with a lot of sobriety. One wouldn't have been sufficient ;)

Every reader is now better having heard both sides of the equation.

Praise Jesus for grace, and for the order that He created. Thanks for your comments WC, and well done.

Guest's picture
Andrew

There is an issue that nobody has touched on yet, and that is what these vehicles are comprised of. It's disingenuous for anyone giving advice to say all ETF's are the same, and all mutual funds are the same. A precious metals ETF for example should be treated very differently in a portfolio than a Utilities ETF. That being said, the most important thing is KNOWING WHAT YOU OWN! If you buy an ETF or a Mutual Fund, your job as the consumer is to know what stocks are represented. If you don't know what's in it, how can you know it's right for you? I am a hedge fund trader myself and I don't like mutual funds and I really don't like ETF's. You should all take your research to the next level and find out what you own; what's backing the ETF symbol that is sitting nice and neat in your portfolio.