Should exchange traded funds (ETFs) be avoided? While we know the benefits of ETFs, sometimes people need a little convincing about their merits when it comes to these funds vs. active management.
According to Wayne Pinsent for Investopedia, index investing is not the way to reach personal investing goals. He makes the case that buying an index and letting it ride is all well and good, but that stocks aren’t always rational. We’ll list his points first, then counter with our own:
1. Pinsent Says: Downside protection. ETFs will go up when the markets are up, but an investor may be caught in the downward spiral when the markets are down.
ETF Trends Says: If you have an exit strategy and use it faithfully, you won’t be vulnerable on the downside. There are also long/shorts that allow you to hedge your current positions, if you’d like to.
2. Pinsent Says: Reactive ability. At times, one company may do well and pull everyone one up, which could create a sector that is overvalued, and vice versa. Investors can gauge companies individually if they are undervalued or overvalued.
ETF Trends Says: ETFs offer so many different strategies to help investors minimize this risk. There’s value-weighting, but there’s also equal weight, revenue weight and more. And again, if one company sinks the whole ship, bring out the exit strategy. Also, there’s not a limited number of indexes out there. Another upside to ETFs is that they help spread around the risk a little.
3. Pinsent Says: Holdings. Indexes have set portfolios. An investor can not pick the individual holdings within an ETF.
ETF Trends Says: This is true, but can you imagine how costly it would be to buy all the stocks in an index with 200 components are more? Let’s face it – the risk that there are some companies you might not like in your ETF is outweighed by the great cost savings. Also with index funds, the legwork, research and time-consuming analysis are all done for you.
Chances are, there’s an ETF out there that holds your favorite company, but if there’s just one you have to own, why not just buy the stock and keep an ETF, too? You’re also not going to be able to tell an active manager what to buy and you’re not even going to know what the manager is buying until the end of the quarter, anyway – the only way to hold exactly what you want to own is to do it all yourself. Do you have that kind of time?
4. Pinsent Says: There Are Limited Strategies. Indexes may not allow an investor access to the varying market strategies, which could result in better risk-adjusted returns. ETFs may also be diversified, but the end result could be achieved with a select amount of individual stocks.
ETF Trends Says: With more than 800 ETFs currently available, this just isn’t true – there are dozens of strategies that investors can put to work and their portfolio can be as narrow or as diversified as they want it to be.
5. Pinsent Says: Lack of Personal Satisfaction. Selection of certain stocks could led to obsessive quotes checking, and it is the same when investing in an index. An ETF investor could be constantly worrying over market performance and the economic outlook. Furthermore, the satisfaction and excitement of being successful through good investments is lost.
ETF Trends Says: When you have a strategy and you stick to it, and you make wise and informed investment decisions based on your own personal needs, how can you not have personal satisfaction? ETFs have made investing accessible to the average person, and anyone who makes a successful trade is going to feel proud and empowered.
Max Chen contributed to this article.