Back then everyone wanted to own large cap growth funds. You could take your pick of hundreds in the category. A few were really good, a few really bad, and most were average. I saw frustrated investors simply give up trying to choose and throw their money at whatever was convenient. Usually it didn't work out so well.
The good news is that the ETF structure should allow us to avoid some of the ill effects of the mutual fund boom.
As Americans, we're all about freedom. We choose our cars from a showroom, our food from a menu, and our flowers from a nursery. We don't like being forced to take whatever happens to be available.
No one likes having too many choices.
It's possible, though, to have too many choices. At some point we get overwhelmed and paralyzed. Then we do nothing — even when we should. This is as true with investing as with everything else and can lead to ...
Now we're approaching the same crossroads in the ETF era. According to my data, at the end of June there were 914 exchange-traded funds and 95 exchange-traded notes available to U.S. investors. That's well over 1,000 choices with more coming to market every week.
Want large cap growth? You have to pick from 13 ETFs now on the market, not counting leveraged and inverse ones. Looking to bet on a sector — technology, for example? More than 30 technology-related ETFs are now available!
Do we need so many ETFs? Yes and no.
Many are duplicative or have a lot of overlap in their portfolio holdings. The big sponsors all want to stay competitive by covering every niche.
To some degree, this is a good thing. Competition leads to better products, more efficiency, and lower costs for everyone. I always appreciate having choices when I make investment decisions.
On the other hand, as the market is sliced into smaller and smaller pieces, investor interest in some segments is simply not enough to support a half-dozen different ETFs.
So what happens is that the biggest firms — the ones with well-known brand names and big marketing budgets — tend to dominate the menu. That's too bad; there are some smaller upstart companies that deserve a break. Yet it's a fact of life.
However, there is a problem when investing in the smaller ETFs ...
The ETF Liquidity Trap
As people who are used to investing in mutual funds switch to ETFs, many run into something they never had to worry about before: Liquidity.
No-load mutual funds can typically be bought and sold at the daily net asset value, or NAV. ETFs are bought and sold on an exchange and their price changes throughout the day.
There are really two prices: The "ask" price, which is what you will pay to buy the shares with a market order; and the "bid" price, which is what you will receive for selling your shares with a market order. The difference between these two prices is what is known as the "spread."
Here's the problem:
The largest 100 or so ETFs typically trade with just a one or two-cent spread. However, small and thinly traded ETFs might have spreads of 10 cents, 20 cents, or more. If, for instance, the share price is around $20, you could lose nearly one percent just buying and selling shares even while the price remains steady.
What this means is that you can't just look at an ETF's past performance when deciding whether to jump in. You also need to consider its size, trading volume, and institutional involvement.
Here is a quick example:
Say you want to invest in the real estate sector. Someone tells you that PowerShares Active U.S. Real Estate Fund (PSR) has done very well, up 52.7 percent in the last twelve months. You do a little checking and find out that PSR edged out iShares Dow Jones U.S. Real Estate (IYR), which gained 51.2 percent in the same period.
Dig a little deeper. It turns out that IYR has assets of more than $2,440 million ($2.4 billion), while PSR only has about $4 million.
Look at the trading activity, too. Average daily dollar volume is more than $900 million for IYR. For PSR, the typical day only generates about $0.2 million in trading activity.
Which do you choose? I know what I would do. Performance in the two ETFs is very similar, but IYR is far bigger and way more actively traded. There are no guarantees, of course. Nevertheless, IYR gives me more assurance I can buy or sell efficiently and at a fair price.
As you can see, it's not hard to lose an extra percent or two on each entry and exit in an illiquid ETF. This can quickly eliminate any performance advantage you think you're getting from a small, unknown fund.
The example above is not just cherry-picking. I could name many other ETFs that look like they have good results but are even smaller and less popular.
I always consider these factors when I'm looking for ETFs. And I try to avoid the small, thinly-traded ones. Should you do likewise?
In my opinion, most people are better off sticking to the beaten path. Once you decide to move into a particular sector or market category, do a little homework and find out which ETFs have the best liquidity in the group.
However, if you have access to reliable, real-time market data and don't mind "working" your orders to get the best prices, you can probably make good use of some smaller ETFs. This takes some time and specialized knowledge.
Either way, ETFs are one of the most useful investment tools to come along in decades. Learn about them, know them, and consider using them!
P.S. My just-released ETF Field Guide includes everything you need to get on the right track for profitable ETF investing. And the companion proprietary ETF Shopper's Handbook gives you easy-to-understand data so you can find the cream of the cream among more than 1,000 ETFs and ETNs. You don't want to be without this one-of-a kind resource if you invest in ETFs. Click here to learn more.
This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.
|< Prev||Next >|
Current Headlines - Finance
US stocks extend recovery after Chinese market surges
U.S. stocks surged Thursday afternoon, putting them on course to rack up big gains for a second straight day, as investors took advantage of this month's sell-off to add to their holdings. The stock market is rebounding from a sharp six-day slump that was triggered by concerns about the health of the Chinese economy.
Planned Parenthood report says fetal tissue videos were distorted
Planned Parenthood told U.S. congressional leaders on Thursday that manipulations and deletions used in the editing process of secretly recorded videos slamming the organization rendered the tapes unreliable for government inquiries. In an 11-page letter to Republican and Democratic congressional leaders, the reproductive healthcare group's president, Cecile Richards, detailed the findings of an analysis conducted by research firm Fusion GPS and commissioned by Planned Parenthood. In recent weeks, the Center for Medical Progress has released eight videos showing Planned Parenthood technicians gathering fetal tissue from abortions.
Tiffany earnings fall as high costs, strong dollar bite
The company, known for its pale blue boxes and iconic Tiffany Diamond, also forecast a surprise 2-5 percent decline in earnings for the year ending January. Tiffany's shares fell as much as 4.2 percent.
FTSE Rallies After See-Saw On Global Markets
The FTSE has rallied and closed up 3.6% after a rollercoaster few days for the global markets sparked by jitters over China. Earlier, mainland China's main stock market, The Shanghai Composite, closed more than 5% higher, above the critical 3,000 level, and its highest jump in eight weeks.
China official blames Fed for global market rout, not yuan
Concerns over a possible U.S. rate rise by the Federal Reserve may have sparked a global stock market rout rather than the devaluation of China's yuan currency, a senior Chinese central bank official told Reuters on Thursday. Yao Yudong, head of the bank's Research Institute of Finance and Banking, said the U.S. central bank should delay any rate hike to give fragile emerging market economies time to prepare. "China's exchange rate reform had nothing to do with the global stock market volatility, it was mainly due to the upcoming U.S. Federal Reserve monetary policy move," Yao said.
Interview - China official blames Fed for global market rout, not yuan
By Kevin Yao BEIJING (Reuters) - Concerns over a possible U.S. rate rise by the Federal Reserve may have sparked a global stock market rout rather than the devaluation of China's yuan currency, a senior Chinese central bank official told Reuters on Thursday. Yao Yudong, head of the bank's Research Institute of Finance and Banking, said the U.S. central bank should delay any rate hike to give fragile emerging market economies time to prepare.
New Hampshire prep school rape trail lawyers make final cases
Closing arguments in the rape trial of a former student at an elite New Hampshire boarding school focused on whether he coerced a 15-year-old classmate into a sexual encounter or whether she accused him to save her reputation. A county prosecutor on Thursday said defendant Owen Labrie, 19, told a friend had he had used "every trick in the book" to get the victim to have sex with him. "You only need tricks if someone says no," Assistant Merrimack County Attorney Joseph Cherniske said.
TV newsrooms pay tribute to slain journalists
Trump on fatal shooting of WDBJ journalists
Jeb, get ahold of yourself