The Most Expensive ETFs You'll Never Need

Exchange-traded funds (ETFs) have been one of the fastest-growing investment products in recent years. Their trading flexibility and low expenses have attracted millions of investors to their doors. But as more and more of these funds are being rushed to market, expenses on some ETFs have begun to creep up. In fact, some ETFs now charge more than many actively managed mutual funds. Why are some of these funds so expensive?

Forecast: rising expenses
According to Morningstar data, 33 ETFs currently clock in with an expense ratio of 0.95% or higher, summarized below:

The 33 Most Expensive Exchange-Traded Funds

1 HealthShares European Specialty Health Fund

15 Claymore Specialty Funds

15 ProShares Ultra Index Funds (leveraged long)

2 ProShares UltraShort Index Funds (leveraged short)

All of these funds serve a much different purpose than most inexpensive, broad-market exchange-traded funds. The funds in the chart allow investors to invest in a more obscure, narrow segments of the market (HealthShares and Claymore), or leverage their bets to twice what the market either gains (ProShares Ultra) or loses (ProShares Ultra Short). In such a case, the added expenses may seem reasonable.

After all, one should expect to pay more for funds that allow investors to engage in these otherwise operationally difficult strategies. While paying up for an ETF that holds shares of commonly held stocks like Microsoft (Nasdaq: MSFT  ) , Wal-Mart (NYSE: WMT  ) , or Procter & Gamble (NYSE: PG  ) doesn't make sense, some ETFs get you shares of obscure companies that don't trade on major U.S. exchanges.

But odds are any investors who are interested in selling the market short or leveraging to twice the market's return are not going to be long-term holders of these types of ETFs. Most people who buy these more expensive ETFs will likely be making frequent trades into and out of these funds, racking up further trading costs and commissions. These funds are made for market timers and not long-term investors; that should make it pretty clear whether or not these funds are right for you.

Proper care and feeding of ETFs
Exchange-traded funds can be an excellent investment vehicle for investors, but only if they are used properly. Just because these funds can be traded throughout the day doesn't mean they should be. ETFs can provide an inexpensive way to get passive exposure to the market, and that is how they are best used by investors. Unfortunately, too many folks take advantage of ETFs' trading flexibility to make frequent trades in an attempt to make a quick short-term profit. Not only are most investors really bad at successfully timing the market, but they also oftentimes pay more for those exotic funds that allow them to do so.

In a perfect world, people who buy ETFs do so because they are satisfied with the market rate of return -- there is no active management within ETFs. At least not yet. And if you are seeking the market rate of return, costs should be of primary importance to you. You want the fund that can get the job done for the smallest expense. Anything above that, and your ETF will start to lag the market, weighed down by unnecessary costs.

So if you are thinking of buying exchange-traded funds, stick to broad-market, well-diversified funds with low expenses. A fund like Vanguard Total Stock Market ETF (VTI), for instance, combines big companies like Google (Nasdaq: GOOG  ) and Verizon (NYSE: VZ  ) with smaller holdings like Ingersoll-Rand (NYSE: IR  ) and Seagate Technology (NYSE: STX  ) . Buy for the long haul, and don't plan on jumping in and out of the market at each sign of uncertainty. 

Although some of the new ETFs may seem alluring, they are too expensive to warrant a place in your portfolio. There is no reason why anyone should overpay to own an exchange-traded fund. Leave the pricey funds to someone else -- your portfolio will thank you.

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This article was originally published on Sept. 26, 2007. It has been updated by Dan Caplinger, who doesn't own shares of the companies mentioned. Wal-Mart and Microsoft are Motley Fool Inside Value picks. Google is a Motley Fool Rule Breakers recommendation. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (6)

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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 December 29, 2008, at 4:43 PM, 181736065 wrote:

    Amanda,

    Good article, however I'd like to point out a couple of things.

    1. ETFs, especially the commodity and currency ETFs, allow you asset class diversification without having to open up, and be exposed to, futures.

    2. ETFs do provide more "sock for the buck". For instance, if you believe Bill Mann when he says that China may be an investment opportunity of a lifetime, you can buy a chinese index fund that is turbocharged twice.

    3. Also, double short ETFs allow for market neutrality (if you just want to "step aside" for awhile but not go through the expense of selling all your positions).

    4. Finally, ETFs are better than mutual funds (more transparency, better tax treatment, lower cost on regular index ETFS) if you believe that there is little chance of beating a market index in a manner significant enough to justify the management time and transaction costs of professional stock picking. Many people - not me - believe this and, respectfully, the results of TMF in its relatively short history has yet to prove the case to be otherwise.

    Regards,

    Bill J.

  • Report this Comment On December 29, 2008, at 6:59 PM, 181736065 wrote:

    Thanks rwnandamassacre,

    Thanks my friend. But so far, I can talk reality. (I have been using these ETFs for months now.)

    I have 33 Hidden Gem Picks totaling about $200,000 in my portfolio and about $70,000 of TZA (Drexion 3X Small Cap Bear), and I can tell you that it has worked to my satisfaction.

    Sure, perhaps the "double or triple" isn't really there, and there isn't an "exact correlation" - but for me, it sure does seem to put a brake on the downside without having to sell my numerous positions!

    Regards,

    Bill J.

  • Report this Comment On May 04, 2009, at 1:29 PM, tgauchat wrote:

    I have to concur with both of the above comments.

    I know that the double ETFs (especially the shorts) have erosion from their goal over anything but the short term, yet, still, they provide simple leveraged returns when you need a hedging bias.

    Finding stocks available to short, these days, are difficult, let alone doing self-leveraging. Ultra-ETFs are a choice, if the investor understands that the correlation will often drift.

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