Stay Far Away From These Dangerous Investments

If you thought ETF and ETN mania was out of control a few years ago, then you have another thing coming.

There are well over 1,000 exchange-traded funds currently listed on U.S. stock exchanges and more than a hundred additional exchange-traded notes. In short, your investing choices are absolutely overwhelming. For instance, let's say you wanted to invest in commodities. If you pulled up options for commodity investing (oil, natural gas, and precious metals), you'd find well in excess of 100 possible ETFs and ETNs.

ETFs are big business, and the issuing companies behind these funds understand that all too well. According to Deutsche Bank, 2011 brought in record cash flows of $163.8 billion to the global ETF industry. Deutsche also estimates that ETF net assets could rise by 15%-20% in 2012, resulting in $137 billion to $190 billion in net new investor inflows.

With that in mind, sometimes these companies don't exactly have investors' best interests in mind when bringing ETFs and exchange-traded notes to market. Right now, the only battle being waged among ETF issuers is who can deliver the most volatile product.

Take, for example, these newly issued ETNs from VelocityShares -- a firm that has made a habit of picking on traders with a penchant for gambling their money away:

ETN

Expense Ratio

VelocityShares 3X Long Brent Crude 1.35%
VelocityShares 3X Inverse Brent Crude 1.35%
VelocityShares 3X Long Natural Gas 1.65%
VelocityShares 3X Inverse Natural Gas 1.65%
VelocityShares 3X Long Crude Oil 1.35%
VelocityShares 3X Inverse Crude Oil 1.35%
VelocityShares 2X Long Copper 1.35%
VelocityShares 2X Inverse Copper 1.35%

Source: IndexUniverse.com.

Not only does daily rebalancing effectively destroy the long-term value of any of these investments, but the expense ratios of 1.35%-1.65% are significantly more than PowerShares' average expense ratio of 0.95% for its leveraged products. Keep in mind that ETFs often pay a dividend; ETNs usually do not. So don't be expecting a dividend anytime soon from these highly levered investment vehicles.

Simply put, buying into gimmicks like these is akin to committing investing suicide as I see it. There are far better ETF choices that could satisfy your urge for diversification than what VelocityShares is attempting to get you to buy into.

If you're looking for copper exposure, the Global X Copper Miners ETF (AMEX: COPX  ) owns shares in 33 separate companies and is yielding 3.7% over the trailing 12 months. If oil is your interest, the United States Oil (AMEX: USO  ) and the lesser-followed United States Brent Oil (AMEX: BNO  ) ETFs are your best bet to mirror the price of West Texas Intermediate or Brent crude, at least over short periods of time. For natural gas, the iPath DJ AIG Natural Gas (AMEX: GAZ  ) ETN offers a lower net expense ratio than some alternatives, but unfortunately it lacks a dividend. That's why, as I mentioned in "It's Time to Buy Natural Gas," I prefer the iShares S&P North American Natural Resources (NYSE: IGE  ) . Combining all natural resources into one basket, this fund yields 1.2%, owns shares in 157 different companies, and boasts a nominal 0.48% expense ratio.

This is how you successfully navigate the ETF market -- not by throwing your money at issues that play on volatility's heartstrings. Do yourself a favor; when you come across a heavily hyped double or triple-levered ETF, run the other direction.

Do you have an ETF mistake you now regret? Tell me about it in the comments section below.

I also invite you to get your copy of our latest special report, "The Shocking Can't-Miss Truth About Your Retirement," which offers up a plethora of tips for maximizing your dollar as you head into retirement. Best of all, this report is completely free for a limited time only!

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. He is merciless when it comes to pointing out bad ETFs. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that puts investors' interests first.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 14, 2012, at 12:21 PM, darachilds wrote:

    I tried to buy USO on my Merril Lynch account and they won't allow it. I thought that was odd, since I had understood it to be somewhat of the standard bearer of oil ETF's.

  • Report this Comment On February 14, 2012, at 3:20 PM, pappapig1 wrote:

    USAGX Has been a big disappointment for me! down 14% since I bought and gold up 600 per ounce? go figure!

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