Hurt

The one thing that did the most to turn me off of mutual funds was their relentless marketing on how diversified they were. Invest in this mutual fund and you are diversified and safe – is what we often heard. All the while, mutual fund companies were charging enormous fees in the form of high MERs to do this.

Sure many mutual funds provided good diversification but there was also this amazing alternative which involved simply buying the entire stock market through an index fund or index ETF and pay way less in fees AND outperform 3/4 of the mutual funds available. However, their marketing efforts were so strong that investors never realised the true costs of owning a mutual fund for many years.[ad#tdg-embedded]

Enter ETFs

This created the heyday for ETFs that we are seeing now. At first there were the good ETFs that allowed investors to buy whole markets in different regions of the world. Using sound asset allocation and portfolio building practices an investor could build a solid portfolio that was very diversified. Then came the niche ETFs and the powerful marketing efforts that surround them. For example, an investor can buy an ETF that is focused on mining companies.

The classic selling point for ETFs is that they provide wide diversification by not selecting one or two of the best stocks in a particular market, but rather buying all the stocks in that market and tying your results to that market. Again, this has proven to be pretty successful – just check out The CoffeeHouse Investor. Now however we are seeing marketing and ads for ETFs tracking niche markets that I believe is hurting investors.

ETF Marketing Effects

It is hurting investors because our goal is to build a portfolio based on sound asset allocation principles to ensure we achieve the right balance between risk and reward. By adding in these niche areas we are making a bet on one particular area of the market as opposed to keeping things simple and investing in wide asset classes such as value or small-cap equities and inflation protected bonds or TIPS. Many inexperienced investors see the marketing efforts of the big ETF companies to invest in that hot market over in Papua New Guinea and add that to their portfolio, adding a whole bunch of risk and uncertainty to their portfolio in one fell swoop. The highly leveraged ETFs are the same thing – these products need to be used (If at all) in a very specific controlled manner or poor results WILL entail.

Summary

I have nothing against a company striving to make money. I am a capitalist through and through. However, what irks me is that just like mutual fund companies have done for years, ETF companies are trying to prey on inexperienced investors by marketing products targeted at niche markets or highly leveraged instruments and showcasing their prior performance and how good it has been. Historical performance tends to have no impact on future performance and the only thing investors can do to protect themselves is to be truly diversified across global markets and hold the right balance between fixed income and equities.

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9 Comments   |  

9 Comments

September 2, 2009, 5:29 am

Oh man, don’t even get me started on this topic.

ETFs have the ability to be even better than index funds. They’re more accessible (you can buy them from any brokerage account). And their expense ratios are even lower than comparable index funds.

Yet you’re absolutely right. They’re turning out to be a tool for investors to demolish their own wealth. Bogle’s “webinar” with Index Universe a while back provided some data on the topic, and it’s not pretty: http://www.indexuniverse.com/sections/newsinfocus/6012-bogle-investors-are-getting-killed-in-etfs.html

September 2, 2009, 5:29 pm

Don’t ETF’s just sound like glorified mutual funds anyways? There was so much bad press on mutual funds for their lack of ability to beat market indexes in the past and that is what I believe lead to the creation of ETF’s. An ETF is essentially just a an open mutual fund that is rebalanced to perform as the market does. They still have management expense ratios (MER’s) so it’s not like you are not paying to have the money managed; sure the MER’s are lower than traditional mutual funds, but that’s just because there is less work involved for the ETF managers.

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