The Basics on Exchange-Traded Funds
Broad vs. Narrow: All ETFs
Are Not Created Equal
You may have heard good things about exchange-traded funds (ETFs) as a cost-effective, tax efficient diversified alternative to mutual funds. And in fact, many ETFs do track broad market indexes such as the S&P 500, the Russell 2000, and the MSCI EAFE index.
But there’s a new reality in the ETF world: a flood of narrow ETFs is hitting the market, many of them highly specialized and potentially highly volatile. Whether tracking an individual country, a specific medical therapy, or an esoteric investing strategy, there’s seemingly an ETF for every imaginable idea (or soon will be).
Critics say these new specialized funds are giving ETFs a bad name, encouraging individual investors to speculate when they should be socking their retirement money into broad market vehicles instead.
“Performance-chasing investors in specialized funds are their own worst enemies,” said Vanguard founder and indexing expert John Bogle in a recent Wall Street Journal editorial, noting that most of the growth in specialized ETFs has been in ‘hot’ areas like small-cap stocks, energy, emerging markets, international, real estate and commodities.
Bogle also noted that ETF trading volume has been high, with 400 million ETF shares changing hands each day (compared to 1.8 billion total daily shares on the NYSE), implying that ETF investors are primarily traders rather than buy-and-hold investors.
Whether Bogle is right and ETFs become a collection of narrow trading vehicles, or he’s wrong and the bulk of the ETF dollars flow to the broader indexes, the bottom line is this: don’t lump all ETFs in the same bucket.
With the right research and planning, ETFs can be used to cost-effectively construct almost any type of portfolio, including a diversified, long-term set of holdings.
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