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Are Exchange Traded Funds Right for You?
My response was as follows:
Thanks for writing and for the kind words. To answer your question (without turning it into a full blown essay on the subject) is relatively straightforward. In my next book, (Investing for the Utterly Confused, McGraw-Hill, due out in January), I address both subjects at length.
I am always skeptical of new products delivered by Wall Street that seem too advantageous to the investor. They often are, once the chaff is removed, quite the opposite. Although the ETF itself is low cost in terms of fees, the brokerage fees, the real disadvantage of this investment, is hardly ever mentioned. Two or three quick trades can quickly eliminate many of the highly touted "pluses" turning them into often-ignored "negatives".
Other arguments such as "a great way to play specific sectors" or "frequent pricing" are a mote point to an investor with a long-term outlook. For the short-term trader, the chance that inside those funds you are buying more downside drag than upside potential increases when betting on a basket of companies as opposed to investing in targeted acquisitions. Why buy a basket if you can target several good companies, buy them, and get out just as easily should your decision turn sour.
ETFs also give the investor the impression that they are investing with some exclusivity. The markets hold no prejudices. Investors in ETFs can get caught in an updraft of enthusiasm - see gold sector ETFs, which have been blamed for the speculative run-up in pricing. They may be lured by the funds comfort zone and be unable to figure out exactly what is happening to their investment in time to react. Sure, the sell button is just a click away. The real problem still lies with determining when to sell. And with no real historical stats to refer to, traders are left to be emotional rather than analytical.
Folks who use low-cost index strategies have none of these problems. They often have determined their own risk and become comfortable in their long-range goals. Some newer indexes have sought to attract investors looking for more, as you probably know all too well. Whether revamping broad market indexes to reflect dividends or other more narrow approaches will attract a significant amount of new investors to warrant their existence remains to be seen.
I tell my readers to keep their portfolios well segregated. Once a retirement account is built and then a tax advantageous portfolio of index funds held outside the tax deferred account is developed, the investor is free to buy long-term individual stocks with good dividends. Once those three accounts are funded, speculate to your heart's content. This is where the investor would place any and all ETFs. But why when you plan on trading frequently should you bother?
ETFs have their place but I'm unsure exactly why anyone would want to own them.
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