I read an amusing article the other day. It wasn't meant to be amusing, I'm sure, but I was chuckling nonetheless. It was a Reuters piece by Mark Wilkinson on ETFs in which he detailed how interest and investments in exchange-traded funds (ETFs) have grown explosively in recent years. True enough.
The article also offered cautions about ETF investing. I can't quibble with that, either. There are many advantages to ETF investing, such as the ability to invest in a group of stocks via a single investment instrument, and their ready availability through your regular brokerage. And there are disadvantages, such as the cost of investing in them via a brokerage if you're only investing small sums periodically.
Here's an interesting point the article made: "The ability to short an ETF also means that unlike most mutual funds, they can be used to bet against the market or a group of stocks. Investors who short stocks borrow and then sell them in the hope of buying them back at a lower price to return to the lender. The only problem is that losses can be uncontrollable if the stocks rise."
Wilkinson then quoted the venerable father of the index fund, John Bogle, who said: "They're like a pretty shotgun: great for hunting but equally perfect for suicide." Bogle noted the frequency of trading among ETFs and called them "vehicles for speculation," suggesting that ETFs may not be good for long-term investors. I beg to differ here. Sure, ETFs may serve speculators well. But that doesn't mean that long-term investors can't profit from them, too. There's no rule against holding ETFs for many years.
The article then quoted money manager William Bernstein, who said, "They are ... like a chainsaw: if used properly it can be very effective, if not it can be very dangerous." This is where I began chuckling -- poor ETFs being likened to shotguns and chainsaws! I started imagining other things that ETFs might resemble:
- Doughnuts. If eaten in moderate quantities, doughnuts can be delicious treats. If consumed by the dozen weekly, they may help you meet your maker earlier than you expected.
- Fertilizer. If used correctly, it can make your flowers and vegetables grow. If used incorrectly, it can kill your garden.
- Beer. Tasty to many people and relatively harmless to many in small quantities, beer can become a problem when overconsumed. And for slugs, well, it's just bad.
- Paper. Used for books, napkins, checks, cereal boxes, and more, paper is indispensable. But get a sharp piece of it and draw it quickly against your skin, and ouch!
Have I made my point? Sure, ETFs can be used ineffectively. But so can many other things.
Learn more about ETFs in our spiffy ETF Center and in these articles: