Just Buy ETFs Right?...Right?
10 Little discussed Problems with ETFs
Just buy ETFs. You get diversification, its passive, and you match the market returns and no one outperforms an index benchmark. This advice is everywhere.
Heck, it is the advice on what you should invest in while trying to fix your financial situation in Your Finances Unfukt.
And when you are just starting your wealth accumulation journey, ETFs are beneficial. You have a small bag and any investment return on that small portfolio will pale in comparison to the money you can make by getting rid of bad debt and increasing your income. This isn’t the time to major in the minor, get market exposure and do it with as little time spent as possible while you continue to grow your income.
But what about after you have a considerable sized portfolio. Are ETFs really the crowning achievement of the investment space? Should you always just own a few ETFs? And more importantly, is owning an ETF really the way to outperform your peers?
Since the gooroos just repeat “buy ETFs” but don’t ever mention the difference between an ETF and buying a diversified stock portfolio (probably due to not knowing any of this, nor ever thinking beyond the surface level), you don’t often hear of the downsides that come with ETFs.
Well I rounded up 10 different costs of ETFs that are almost never discussed. This is the knowledge you didn’t know you needed.
What are ETFs?
First, some background. An ETF is an exchange-traded fund and is similar to a mutual fund but with some potential tax efficiencies. Each ETF is a separate investment vehicle, with its own ticker, that you can buy and sell on a stock exchange just like a regular stock.
But unlike regular stocks, ETFs are a basket of securities and by purchasing a share of an ETF you are getting a small piece of all the companies the ETF owns. In this way, you can achieve diversification with little money by instantly owning a handful of companies.
ETFs have an investment mandate they must follow, but within that mandate they can buy any security. For instance, a large-cap ETF may only be allowed to hold shares of a company that has a certain market cap.
Many ETFs are made to passively track one of the main stock market indices, like the S&P500, and will have all the different shares and hold them at roughly the same weight they have in the index - for example VOO 0.00%↑ which is Vanguards S&P500 index ETF.
There are many different flavors of ETF from passive to active, and broad based to focused. Some ETFs are levered to return 2 or 3x the daily returns and some are inverse and return the opposite of an index.
For our purpose, you can think of owning an ETF as owning a diversified mix of stocks.