Why ETF are dangerous
ETFs: Why They Are Dangerous - Barrons.com
Can there be too much of a good thing? Mae West didn't think so, but I have it on good authority she wasn't referring to exchange-traded funds (ETFs).
New research shows that the very features of ETFs that make them so attractive are actually leading many investors to earn lower returns. The problem with ETFs is not that they are inherently flawed; it's just that they tempt investors into money-losing behavior.
ETFs' virtues are well known. To name a few: They are relatively inexpensive (see Focus on Funds), tax-efficient, and provide immediate portfolio diversification through a single transaction. They also are incredibly convenient: They can be bought or sold at any time of the trading day, and even sold short.
This ease of trading turns out to be their Achilles' heel, however. Consider a new academic study by Utpal Bhattacharya, a finance professor at Indiana University's school of business, and four colleagues at Goethe University in Germany. The study, "The Dark Side of ETFs and Index Funds," found that "easy-to-trade index-linked securities" such as ETFs encourage users to "make bets on market phases, and they bet wrong."
The researchers reached this conclusion by analyzing a dataset containing all the portfolio transactions between 2005 and 2010 of nearly 8,000 clients of an online German brokerage firm. This extensive dataset allowed the researchers to focus separately on those investors who began investing in ETFs during this period. Believe it or not, the average performance of the investors in this subset was lower than that of the remainder of investors who did not.
To make sure that ETFs were the culprit in this underperformance, rather than some other factor, the researchers next compared the returns of each investor's portfolio before and after the purchase of the first ETF. They found that, on average, these investors' performance was lower after than before. And, to pound the nail in ETFs' coffin,
Can there be too much of a good thing? Mae West didn't think so, but I have it on good authority she wasn't referring to exchange-traded funds (ETFs).
New research shows that the very features of ETFs that make them so attractive are actually leading many investors to earn lower returns. The problem with ETFs is not that they are inherently flawed; it's just that they tempt investors into money-losing behavior.
ETFs' virtues are well known. To name a few: They are relatively inexpensive (see Focus on Funds), tax-efficient, and provide immediate portfolio diversification through a single transaction. They also are incredibly convenient: They can be bought or sold at any time of the trading day, and even sold short.
This ease of trading turns out to be their Achilles' heel, however. Consider a new academic study by Utpal Bhattacharya, a finance professor at Indiana University's school of business, and four colleagues at Goethe University in Germany. The study, "The Dark Side of ETFs and Index Funds," found that "easy-to-trade index-linked securities" such as ETFs encourage users to "make bets on market phases, and they bet wrong."
The researchers reached this conclusion by analyzing a dataset containing all the portfolio transactions between 2005 and 2010 of nearly 8,000 clients of an online German brokerage firm. This extensive dataset allowed the researchers to focus separately on those investors who began investing in ETFs during this period. Believe it or not, the average performance of the investors in this subset was lower than that of the remainder of investors who did not.
To make sure that ETFs were the culprit in this underperformance, rather than some other factor, the researchers next compared the returns of each investor's portfolio before and after the purchase of the first ETF. They found that, on average, these investors' performance was lower after than before. And, to pound the nail in ETFs' coffin,