Why ETFs Suck

June 12th, 2010

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UPDATE: After reviewing all of the comments and thinking about this long and hard, I’ve published a counter article that sheds light on the positives of ETFs. Please check it out to get a more balanced view of what they are and what they can do. Also check out Xin Lu’s article on ETFs.

ETFs burst onto the scene a few years ago and have gotten more and more popular. They have a very specific purpose, but most investors are better off staying away from them, and I’m going to show you why.

What Is an ETF?

ETF stands for exchange-traded fund and it’s basically a glorified mutual fund that represents an index or collection of stocks. So what’s the difference between an ETF and a mutual fund? Well, an ETF looks more like a stock: you can trade it like a stock since its price changes throughout the day.

Who Cares?

Traders, that’s who. Everyday people like you and me who are used to putting our money into mutual funds should simply disregard ETFs. They don’t apply to us and despite what everyone says, they won’t give you any advantage when making investment decisions.

Why They Suck

ETFs suck for a very simple reason: everyone is talking about them and are all excited by them (even I was an early convert), but no one is saying that only a very tiny slice of the population can truly benefit from ETFs.

Traders use them to trade in an out of indices like the S&P 500, commodities like gold and oil, and currencies like the Euro. They also use them to short these specific markets. Traders trade and that means buying and selling a lot throughout the day to make money.

The rest of us aren’t doing this. We’re investing for the long terms so we can retire without having to move in with our kids and totally cramp their style. Using ETFs in your retirement account is a monumental mistake.

Top Things I Hate About ETFs:

Fees: With mutual funds you pay an annual expense ratio but with ETFs you pay a fee every time you buy some of it, just like a stock. These fees pile up pretty quick.
Hype: Because they’re new and few people have taken the time to think through the down side, most investors just buy into the hype instead of thinking critically about how these work and if they’re a good fit for them.
Traders: If traders are using them, then I don’t want any part of them. Nothing against traders, but they go in and out of their holdings so fast that you’ll eventually get left in the dust. Not ideal.

ETFs aren’t evil, they’re just not for the masses. Stick to good ol’ fashioned mutual funds and index funds unless you want to play ball with the traders.

God help you.

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