Are ETFs Too Risky?

There’s a lot of news out there about ETFs lately, focusing on their negatives. They’re an untested instrument. The bid-ask spreads are too wide. They tempt people into trading when they should be holding on to their investments.

My book on wealth recommends using ETFs as the instrument with which to build a diversified mix of stocks and bonds, a time tested approach to accumulating wealth over the long haul. Just in time to discredit the rash of negative reports is a great Schwab article on the facts of ETFs.

Like anything, ETFs are an instrument, and can be used for good or evil. Like any instrument, the ETF in question can be sharp or blunt. Here’s the lowdown on why they’re still useful and things to look out for:

  • You don’t have to worry about the wide bid-ask spread at times. If you’re using ETFs as a mutual fund substitute, you shouldn’t be looking at daily prices and being tempted to trade in and out. Broad market stock or bond ETFs are meant as vehicles for investing. Even though they offer you the ability to trade in or out at any time as easily as individual stocks doesn’t mean we should. Moving too much incurs frictional trading expenses and incurs taxes.
  • For the same reason, you shouldn’t worry about temporary fluctuations in value versus the underlying asset. 99.9% of the time the two will be correlated. When things are derailed, it will be temporary (usually minutes at most), so hold on to your investment through the panic. Chances are you won’t even notice that anything happened unless you obsessively follow the market every day, which you shouldn’t be doing.
  • Stick to the tried and true (broad market funds). Don’t get suckered in by fancy ETFs such as triple inverse or super sector specific funds. Those exotic instruments usually have much higher expenses (you can see how much on Morningstar) and offer no benefit for long-term investors.

As you can see, ETFs are not to be feared, but rather something that the wise ones can control. Use ETFs like this and stay on the slow but steady well-trod path to wealth. Tune out the noise and you will prosper.

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