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Exchange Traded Funds: Make bad decisions cheaper and easier

Posted By Pat McKeough On May 25, 2009 @ 2:15 pm In Mutual Funds | Comments Disabled

Exchange Traded Funds, or ETFs, don’t load you up with heavy management fees, nor do they tie you down with heavy redemption charges if you decide to get out before six years have passed. Instead, they give you a lower-cost and more flexible and convenient alternative to mutual funds.

The problem is that ETFs are just as helpful for facilitating smart moves as they are for dumb ones. And there are all sorts of dumb moves that ETFs can facilitate.

ETFs are set up to mirror the performance of a stock market index or sub-index. They hold a more-or-less fixed selection of securities that are chosen to represent the holdings that go into the calculation of the index or sub-index.

This way, if you get an urge to invest in oil stocks, or gold stocks, or Swedish stocks, or wind-power stocks, or any of hundreds of other stock groups, you can act on that urge without doing any messy and time-consuming research on individual stocks.

In fact, since ETFs also trade on stock exchanges, you can buy or sell them any time the exchange is open. With conventional mutual funds, you can only buy or sell at the end of the day, at a price that reflects the value of the fund’s holdings at the close of trading.

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You can also buy ETFs on margin, so your broker can provide instant financing for a portion of your purchase.

Many investors are seduced by the flexibility and low fees of ETFs, compared to conventional mutual funds. They overlook the fact that ETFs don’t add any value to the underlying investment, nor do they improve your market timing. They simply make it cheaper and more convenient to buy or sell.

Many brokers and portfolio managers have built their businesses around ETFs. Their sales literature focuses on how easy it is to invest in classes of investments. It’s a great marketing gimmick, but it subverts the prime advantage of ETFs, which is their low cost.

By the time the ETF specialists add their fees and commissions, their clients are paying the equivalent of actively managed MERs to buy what amounts to a hodge-podge of index funds.

Liquidity and access to margin borrowing can come in handy, and low fees are better than high fees. But most successful investors owe much of their success to holding a diversified portfolio of well-established companies over a period of years, if not decades.

ETFs are more likely to lead you away from that path than help you follow it.

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URLs in this post:

[1] Canadian Wealth Advisor: http://www.tsinetwork.ca/publications/canadian-wealth-advisor/canadian-wealth-advisor/

[2] Click here.: http://www.tsinetwork.ca/publications/choose-newsletter-publication-format/?product_id=619&mqsc=SiteAdCWA2

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