Exchange-traded funds, or ETFs, seem to be the Shimmer of the investing world. They’re the solution to every investment dilemma. Unfortunately, they are often misunderstood and frequently abused.
First, a definition. ETFs are nothing more than a mutual fund that trades on an exchange, like a stock. They first became popular because of their low fees and the ability to trade them during market hours — unlike mutual funds, which can only be bought or sold at the close of trading.
Unfortunately, many investors have fallen for the traps set by the brokerage industry. Because you can trade them, many investors do trade them – frequently – generating commissions and taxes, and reducing investor returns. Studies estimate that these commissions and the “bid/offer spread” you pay on the stock market often wipes out ETFs’ cost advantage over traditional mutual funds. The industry has created all kinds of ETFs that track very narrow indices or sectors — the equivalent to the dangerous art of stock-picking. There are also many ETFs with embedded derivatives and leverage that can leave investors with huge losses if the market moves against you.
ETFs are not inherently bad. If you buy them the way you should buy a mutual fund — look for a low-fee, broadly diversified ETF and hold it for the long-term — they can work just as well as a traditional fund. Many can even be less expensive. But be careful, because they can be just as dangerous as putting floor wax on your butterscotch pudding.
Aficionados of Saturday Night Live’s early years may remember a classic spoof commercial for “New Shimmer”:
Gilda Radner: “New Shimmer is a floor wax!”
Dan Ackroyd: “No, new Shimmer is a dessert topping!”
Chevy Chase: “Hey, calm down you two! It’s a floor wax and a dessert topping.”
Chase sprays it on Radner’s mop and Ackroyd’s butterscotch pudding.
Ackroyd: “Mmm, tastes terrific.”
Radner: “And just look at that shine!”
The SNL link is here: https://www.nbc.com/saturday-night-live/video/shimmer-floor-wax/n8625/.