ETF Investors: Don't Do It Wrong

May 21, 2018
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This past issue of Barron’s had an interesting article on the Father of Index Investing, Jack Bogle.

While the creation of index funds revolutionized the capital allocation process, there is a difference in how to effectively utilize the various vehicles:

Bogle will cop to one thing. The evolution of the index fund has created ETFs, which entice investors to trade, instead of hold for the long term. The turnover in ETFs alarms him: 785% in the 100 largest, versus 144% for the 100 largest stocks. “The difference between traditional index funds [what he calls “TIFs”] and exchanged-traded index funds are like night and day,” he tells Barron’s tartly. ETFs, he says, are the way passive indexing “morphs into active management” and its attendant problems, including increased transaction costs and market timing.

Then he drops the mic and outlines why speculating is so difficult (emphasis mine):

Bogle fears that ETFs are purely speculative, encouraging selling at the bottom and buying at the top. Bogle shared his analysis of dollar-weighted investor returns, which accounts for money flows, with Barron’s. The research shows that from 2005 to 2017, the average investor return from “Traditional Index Funds” was 8.4%. For actively managed funds, it was 7.2%. For ETFs, it was 5.5%, even worse than actively managed funds. That contains the seeds of the category’s demise. “How long are investors going to be happy with that? Sure if you double your money, why would you complain? But you could have tripled it. I am glad we continue to be primarily on the TIF horse, and not the ETF horse.” He also foresees that growth in ETFs will slow because “an awful lot of [market] niches have been populated.” Next up, “a lot of ETFs will go out of business along the way.”

True because you can buy and sell ETF’s just like an indivudual stock and short them. Many traders use these vehicles to get quick exposure to an asset class as they build positions in individual stocks or short these to hedge their portfolio or profit on the downside:

To be sure, his concerns might be overstated. After all, there are plenty of legitimate short-term uses for ETFs, hedging, for one. A 2012 Vanguard study of 3.2 million transactions showed that most ETF individual investors hold for the long term. And advisors who might otherwise have put clients into high-fee funds are recommending ETFs.

While there are many advantages to indexing and ETF usage, make sure you are utilizing these strategies properly in order to meet your long-term financial goals.


Stay Tuned, Disciplined & Patient! {TJM}

The Investor & Character Equation (ICE) | S + R = O


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