Exchange traded funds have been a huge success among retail investors and financial advisors. However, as an investment tool, individuals should have a plan in place to optimally utilize ETFs and to reduce any potential risks.
“Perhaps the biggest lesson over the past two decades is this: ETFs are not bad by design, but rather in the way we use them,” David Berman writes for the Globe and Mail. “To get the most from this investing revolution, it’s necessary to keep your emotions in check. That is one skill that financial innovation has not yet rendered obsolete.”
Specifically, Berman points to the growing number of investors that have increasingly used ETFs as a tool to speculate on a market segment. Investors enjoy the ability to jump in and out of the stock market with a quick trade.
“One temptation, which is stock picking, has been curbed with ETFs,” Utpal Bhattacharya, a professor at the Kelley School of Business at Indiana University. “But another temptation, which is market timing, has increased.”
While there are temptations to day trade with ETFs, the claims about ETFs converting investors into day traders may be overblown.
“Our individual investor data show that the majority of both traditional mutual fund and ETF investments are held in a prudent, buy-and-hold manner,” Joel Dickson, a principal in the Vanguard Investment Strategy Group, said in an ETFguide article. [Are ETFs Turning Investors Into Day Traders?]
With ETFs, investors have the option and flexibility to trade throughout the day if they need it, instead of only being able to buy or sell mutual funds at the close. [An ETF Trend-Following Plan for All Seasons]
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.