The exchange traded fund (ETF) is an invention that is a boon to most investors. But as something grows, naturally there are going to be discussions about whether it’s too much, too fast, too soon and so on. As ETFs explode in number and assets, it’s no wonder that they’ve been the focus of such debates.
In 1993, the ETF was simple: create funds that hold every noteworthy security in a market that is worthy and make it trade like a stock while keeping fees and expenses to a minimum. In 2008, and there are almost 800 different ETFs trading, with some so specialized and narrow, they are facing liquidation.
Jason Zweig for The Wall Street Journal explains that nearly half of the 800 ETFs listed have less than $50 million, and will be too small to survive. When an ETF shuts down, it liquidates and sells its portfolio, giving back money to its investors at net asset value (NAV). In 2008, 25 ETFS have shut down, and all have given back to their investors.
I’m a big fan of Jason, both personally and of his book, “Your Money & Your Brain,” which is an excellent read for the modern-day investor who’s trying to understand how they think about the markets when they’re up or down. But Jason – has the summer heat gotten to you a bit?
Some of his points are:
- Big is beautiful. Stick to ETFs that have at least $50 million in assets. We do agree with this to a point. Investors who are just getting into ETFs would do well to stick to the larger funds. But just because a fund is under $50 million doesn’t mean that it’s at risk for closure. Because of their low expenses, it doesn’t take a lot of money to keep an ETF alive.
- Avoid the fringe. Stay with mainstream indexes and stocks. Do not take the narrow, isolated path. We think investors who do this are cheating themselves out of one of the best things ETFs have to offer. ETFs represent so many diverse areas, and especially now that domestic and global markets are challenged, there are some areas and sectors that are actually doing quite well. In times like this, those narrow ETFs are a great way to diversify and take advantage of moving areas. Ignore them, and you’ll be missing out.
- Do not pay to get out. Hang on until the bitter end. Once the fund is redeemed, you will get cashed out without any brokerage commissions. Most conventional brokers charge $10-$12 for a trade – not a huge penalty to move into something else if the fund you’re in is closing down. If you’re looking to save $12, you’ve got bigger problems than a closing fund.
Yes, there will be ETFs that close, and new ETFs that come along to replace them. Don’t forget – this industry is still in relative infancy. Many of these companies are going into it with the mindset that they’re developing funds for the long term. No one is expecting to shoot right out of the gate.
There are so many more positives going for ETFs than negatives against them. They’ve revolutionized investing for the average person.
Let’s talk instead about the many mutual funds that shut down or consolidate each year, or how most of the existing ones underperform their benchmarks.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.