The Case Against ETFs

Are you missing out on big profits by not owning ETFs?

Exchange Traded Funds (or ETFs) now have over a TRILLION dollars in assets. They’ve been promoted as the worthy successor to mutual funds, a way to make stock investing easier, and much more.

But are they right for you?

This is a trillion-dollar question, so today I’m going to help you with this tough decision. First, I’m going to explain what exactly an ETF is and how it might fit into your investing strategy. Then, I’m going to describe some of the particular conditions of this market, and why they should make you think twice about going the way of the ETF. Finally, I’ll show you the tools you need to take advantage of the stock pickers’ market.

To start, what exactly is an ETF? Well, ETFs are marketed as mutual funds for the 21st century. But are they really?

There are a few key differences. Mutual funds operate by pooling the buying power of many individual investors to buy a basket of stocks or bonds, and then delivering a share of the profits that big pool of money creates. ETFs promise much the similar thing, but with lower costs, the ability to trade during market hours (mutual funds are only priced once per day, after trading closes), and are much more specialized, allowing you to invest in a very small slice of the market if you so desire. For instance, there are:

  • ETFs that are meant to track the major indices
  • ETFs that track only a certain sector
  • ETFs that "short" a sector and go up when the stocks in that sector go down
  • ETFs that track the price of gold and other valuable commodities

And this just scratches the surface. There are endless options, limited only by the ETF providers’ imagination. And because these funds are "exchange traded" just like stocks, they allow investors to customize their portfolios.

One big difference is that to date, all ETFs are essentially indexes. Once the ETF provider decides he wants to track, say Australian stocks, he creates an ETF with a representative group of Aussie stocks. There is no management of the ETF—it simply does whatever the underlying stocks do. There are index mutual funds that follow this same strategy, but most mutual funds have active management. A manager or team of investment professionals is constantly changing the composition of the mutual fund in an effort to create the highest return for the fund’s shareholders.

While mutual funds have been around since the Great Depression, ETFs are barely twenty years old. So, while there are some intrinsic benefits to holding an ETF, they’re not as time-tested as the traditional investment vehicles like stocks and mutual funds. For example, some ETFs are especially susceptible to big price swings during after-hours trading.

And lately, ETFs have become more volatile during intra-day trading. August 24 in particular was a bloodbath; big, multi-billion-dollar ETFs traded up to a 30% discount that morning. Then, on October 24 we had another flash crash, thanks to pricing problems from BNY Mellon, which provides pricing to ETFs. There have been so many customer complaints that the SEC is now involved.

To add insult to injury, outside of the major ETF families (like iShares), many ETFs have low trading volume, which could raise your transaction costs if you trade them frequently. Before the capitulation day in August, Stanford and UCLA released a study claiming that ETFs are much more costly than stocks.

Several years ago, ETFs were a viable way to participate in the upward movements of entire hot sectors. Stocks were trading in a pack, and the best way to scoop up some extra profits was in sector ETFs. However, today stocks are now moving independently of their sectors, removing what was the core benefit of the ETF sector strategy. We have seen, and will continue to see, far greater returns from individual blue chip stock picks.

This is now a sink-or-swim market. Investors are becoming picky, selecting only premium stocks, and it pays to single out these winners and not try to play the whole sector.

Because our system has proven its ability to isolate fundamentally superior stocks, why would you waste your time in watered-down sector ETFs that include weaker stocks?

That’s why, when you use my Portfolio Grader system, you have the perfect tool to set out on your own and beat investors who have a herd mentality. Just take a moment to visit my Portfolio Grader website, and you’ll immediately see that you can click through the best stocks by sector, the best stocks in terms of fundamentals, as well as the best stocks by volatility ranking. You can plug in your current portfolio to see how it fares in my rating system. My proprietary system serves as a great way to gauge how your stocks should fare in the months ahead.

So, if you’re still in sector ETFs, consider this your wake-up call. The real money will be made by investors hand-picking the choicest stocks. With a little confidence and some good stock-by-stock analysis (courtesy of Portfolio Grader), you can become a stock-picking whiz in no time!

Sincerely,

Louis Navellier

Louis Navellier

More Louis Navellier

Twitter

Facebook

RSS Feed

Little Book

InvestorPlace Network

InvestorPlace.com