ETFs Are Not Suitable for Most Investors
This article appears courtesy of RiskHedge, LLC.
Bu Jared Dillian
I used to trade over a $1 billion a day in ETFs.
And I’m here to tell you that most people are better off investing in open-end mutual funds than ETFs. Mostly because ETFs are misused.
I am not mad at ETFs or anything. I just think they encourage short-term trading rather than long-term investing.
It’s because of a subtle difference in the structure.
With a mutual fund, you mail them a check (or the electronic equivalent) and you buy shares of that particular investment company at the net asset value, determined once daily.
You can’t watch it during the day—it doesn’t do anything. Sure, you can guesstimate where they will end up at the end of the day based on market action, but that isn’t very productive.
In the old days, you would look at your mutual funds in the newspaper (really), once every couple of weeks or so. That is how it is supposed to be done.
An ETF, you can watch… second by second, tick by tick. I don’t care what kind of market psychology ninja you think you are—when you see something trading tick by tick, it’s a lot different than something that prints once at the end of the day.
If it starts to go down, you might feel compelled to sell it, which pretty much goes against anything and everything a financial advisor will tell you. Leave it alone, and let it compound.
It’s what we do at ETF 20/20. But if you’re going it alone, it’s not so easy when you can pull it up on your Robinhood app and stare at it.
ETFs Are Not Meant for Short-Term Trading
For the above reasons, a lot of investors think of ETFs as short-term money, and mutual funds as long-term money. That’s a dumb way of looking at it, because both should be thought of as long-term money.
I am the psychology guy.
My core belief is that investor psychology drives the majority of returns. If you think about it, an active ETF should roughly equal an active mutual fund, and a passive ETF should roughly equal a passive mutual fund.
But because they’re structured very differently, investors typically use ETFs for speculation. Blockchain, cannabis, double-inverse leveraged volatility, etc. The mutual fund industry is still pretty boring. And that is a good thing.
You should invest in boring things if you don’t know how to invest in interesting things.
Despite What I’ve Said, ETFs Are Your Friend
All that said, I am no financial Luddite.
I think the ETF is one of the top five financial innovations of the last 100 years! Giving people access to stuff they never had access to before is a great development.
Thirty years ago, you couldn’t buy Indonesia at all. OK—maybe there was a closed-end fund, but that has its own issues. Aside from that, the only way to buy Indonesia was to be Mr. Big Time Portfolio Manager and access foreign markets through a big broker like Goldman Sachs.
And UCITS ETFs are much cheaper than mutual funds.
So I would never be so paternalistic as to suggest that people should be prevented from trading this stuff for their own good. No. What I am saying is you have to use properly.
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