- Exchange-traded funds (ETFs) have been around since the early ’90s, but have exploded in popularity in the past few years — and with good reason.
ETFs trade like a stock, but track an index, commodity or a basket of securities that represent a particular market sector. They offer investors immense diversity, as well as a way to mitigate the risk associated with a single asset.
Despite their popularity, though, there are a number of misconceptions about ETF investing. And if you’re buying into any of them, chances are you aren’t making the best use possible (and most money) out of these diverse investment vehicles.
Keep reading to make sure you’re not falling victim to any of these ETF fallacies.
- Some investors think it’s always best to own index ETFs like the Dow Diamonds (DIA), PowerShares QQQ Trust (QQQQ) and the S&P 500 SPDR (SPY). In reality, though, the best ETFs to own are the ones that help you to reach your own unique financial goals. And just because a certain ETF is popular, heavily advertised or widely followed, doesn’t necessarily make it better than other ETFs.
Instead of focusing on one or two individual funds, try building a portfolio of ETFs that offer broad exposure to key asset classes like stocks, bonds, commodities and real estate.
- ETFs, like mutual funds, come in a variety of shapes and sizes. The level of risk in an ETF or mutual fund is often determined by the portfolio holdings within the fund.
Some indexes, industry sectors or markets will be more risky or volatile than others. However, there’s no substantiated investment research to prove that ETFs are any more or less risky compared to mutual funds.
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Next: ETFs are Only for Day Traders and Short-term Investors
- The truth is that ETFs are effective portfolio building tools for all types of investors.
While ETFs are often used by active investors as trading vehicles, they can be effectively used by buy-and-hold or long-term investors. Whereas one investor may purchase a particular ETF to hedge, another may purchase the exact same ETF with a completely different strategy, such as growing capital.
The unique product design of ETFs allows people with different investment objectives to own the same fund and still accomplish their goals.
Learn how to Build Your Own ETF With Options.
- In any given year, some stocks and mutual funds may outperform certain ETFs, whereas during other time periods they’ll underperform.
The economy, inflation, interest rates and market conditions are a few factors that will impact performance. No one knows with any certainty which stocks, mutual funds or ETFs will perform the best in the future.
- Even though ETFs are traded on major stock exchanges alongside individual stocks, they are not the same. Rather, ETFs consist of an underlying portfolio of securities that’s designed to follow a specific index or investment strategy.
ETFs are typically more diversified than individual stocks.
- Even though fund marketers may present financial data that shows actively managed or fundamentally weighted ETFs outperforming traditional market-cap weighted index ETFs, the numbers are hypothetical.
Supposing that alternatively weighted indexes hypothetically outperformed, it’s important to understand there’s no guarantee they will do so in the future.
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Myth #7: ETFs are More Expensive Than Mutual Funds
Some people think ETFs are more expensive than mutual funds because you have to pay a brokerage commission to buy them.
Generally speaking, investors buying or selling ETFs will pay a brokerage commission, whereas investors buying or selling no-load mutual funds pay none. However, some brokers impose a commission to buy or sell no-load mutual funds. Also, many mutual funds (even no-loads) impose back-end redemption charges for selling their funds before a restricted time period.
Any fair-cost analysis between ETFs and mutual funds should look at the entire spectrum of expenses — not just the transaction fee to acquire the fund. Investors should pay attention to financial costs such as expense ratios, brokerage commissions associated with the fund’s internal portfolio turnover, and tax efficiency.
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