ETF Store Insight

Are ETFs a Better Way to Invest? You Decide.

February 26th, 2014 by Nathan Geraci

Nathan Geraci is President of The ETF Store, Inc. and host of the weekly radio show The ETF Store Show“.

Reasonable minds can certainly differ on the best approach to investing – whether debating specific investment strategies or the underlying investments used to accomplish those strategies.  For hundreds of years, extremely smart and talented individuals from all walks of life have attempted to find a way to gain an edge on the financial markets.  Select any of a seemingly infinite number of investment approaches and you will likely find a highly competent, well-educated investment professional who can present an articulate argument on why that approach is superior.  It’s the nature of the markets – it’s what makes Wall Street tick.  If there were no competing forces in the financial markets, they would grind to a halt.  There are no winners without the losers.  It’s a dog eat dog world.

However, despite the best efforts of investors, we know that no single investment strategy or investment vehicle has definitively been declared the winner – otherwise, every investor would simply mimic that guaranteed approach and scoop up easy money.  Furthermore, given the diversity of investor needs, there’s no “one size fits all” approach to investing.  What works for one investor might not work for another.  Which brings us to Exchange Traded Funds, or ETFs.

As investors continue to move their money out of mutual funds and into ETFs, ETFs have been the subject of much debate in the investment world – “are ETFs a better way to invest than mutual funds?” or “are ETFs a marketing gimmick?”.  These are real questions being posed.  This comes as no surprise given the nature of the financial markets, as described earlier.  If there is an investment product that some believe might give them a better chance at success, there are likely others who believe it doesn’t.  But while these discussions surrounding ETFs have generally been healthy (and positive), it is becoming clear that some corners of the investment universe are determined to simply disparage ETFs altogether.  From “ETFs caused the Flash Crash” to “ETFs are financial weapons of mass destruction” to “ETF are a financial bubble”, there is no shortage of sensationalized articles attempting to scare investors away from ETFs.  Perhaps that fits into the narrative above that there will always be investors arguing both sides of any investment approach or the best vehicle to implement that approach.  Or, it could be that there are lucrative financial incentives for other investment products to protect their turf, so-to-speak.  But that’s a discussion for another time.

The important point here is a simple one:  for any investor who may be new to ETFs, as with any investment, it is critically important to do your own homework on whether they are the right investment vehicle given your specific objectives.  It is also important to understand that not all ETFs are created equal.  Just like with any product, whether investments or automobiles, you will find both good and bad examples.  You can find countless instances of poor stocks (Enron), underperforming mutual funds (see here), and annuities with egregious fees (usually, these two go hand in hand).  You can also buy a fancy sports car that finds itself in the repair shop every other month.  That doesn’t necessarily mean that all stocks, mutual funds, annuities or fancy sports cars should be portrayed in a negative light. It is also important to note that plenty of products may fit one individual’s needs, but not another’s.  When it comes to investing, a basic golden rule is to always understand what you are investing in.  You wouldn’t buy a car without researching the reliability, quality, and safety record.  You wouldn’t buy a Lamborghini to shuttle your kids to soccer practice.  You shouldn’t buy an investment unless you understand how it works, what it’s designed to do, how much it costs – and whether it’s right for your situation.

At The ETF Store, we spend countless hours researching all types of investments.  It is our opinion that ETFs are the best way to build investment portfolios.  We then further tailor those investment portfolios based on the unique situations of our clients.  However, regardless of whether or not you agree with our conclusion on ETFs or if you prefer individual stocks and bonds or mutual funds, there are several facts we believe are not up for debate when it comes to investing:

-Lower investment costs are better than higher investment costs.

-Paying less in taxes is better than paying more in taxes (unless you’re extremely patriotic, altruistic, or have more money than you know what to do with).

-When managing risk, diversification is better than no or minimal diversification.

-Knowing exactly what you own every day is better than knowing what you own every quarter.

Given this, let’s compare ETFs to mutual funds, for example.  ETFs, on average, are lower cost than mutual funds, more transparent than mutual funds (ETFs report holdings daily; mutual funds quarterly), more tax efficient, and can allow you to access asset classes which can potentially increase the diversification of your portfolio.  ETFs also allow you to buy or sell shares during the trading day – though reasonable minds could argue on the benefits of this feature. Note the statement above says “on average”.  There are examples where mutual funds are less expensive than ETFs, or more tax efficient.  The key is to recognize the importance of these factors (investment costs, tax implications, diversification, and transparency) to long-term investing success.  It is our belief that ETFs, as a whole, give you the best chance at building a low cost, tax efficient, diversified portfolio where you know exactly what you own every single day.

Another way to think about this is, when it comes to investing, you want to control the things you have the ability to control.  You can control investment costs, tax events, diversification, and understanding what your investments hold.  You cannot control the financial markets.  We can debate the best investment strategy or the optimal investments to achieve those strategies, but be wary of articles or statements declaring a particular investment product the magic elixir to beating the market (or on the other extreme, that it might usher in the apocalypse!).  Control the things you can, ignore the substantial market noise around you, and take a longer-term view of the markets.  Are ETFs a better way to invest?  That’s for you to decide.  Just be sure to learn all of the facts about any investment before you hand over your hard earned money and do not rely on headlines such as “the growing case against ETFs” to dissuade you from giving your hard earned money the best chance to grow.