Beware of investment concepts that add unnecessary features, and so increase fees and risk. These “bells & whistles” may seem like attractive enhancements, but they’re usually just thinly veiled marketing campaigns.
Even if they call them by some other name, most successful investors identify “bells & whistles” as investment concepts to avoid. The term refers to nonessential features or enhancements that aim to add commercial appeal to a newly created product. Like real bells and whistles, these embellishments attract attention but add little if any value. In fact, they may detract from a product’s value.
Less likely to harbour hidden risks
“Here’s a good general rule to follow when choosing investments: Simple is better. The easier an investment is to explain and understand, the less likely it is to harbour hidden risks and costs that can only work against you. As the old investor saying goes, “Stick with plain vanilla.”
Pat McKeough explains why in this special report and recommends 11 ETFs for a stronger portfolio.
Investment concepts can be marketing plans in disguise
When investment firms create new financial products, they follow the lead of the top marketers of fast food, consumer products, smartphones and so on. Each of them studies their customers to see what appeals to them. Once they discover a feature that has appeal—it may be “high definition” or “gluten-free” or “hedged against the Canadian dollar”—they add it to the mix to make the product more saleable. The feature need not be a good use of the customer’s money, or a healthful choice, or otherwise in the customers’ best interest.
You may want to try a hamburger that comes packaged between two waffles, rather than two halves of a bun. Eating one of those sandwiches won’t kill you. But buying a financial product with a non-essential feature is apt to lower the long-term return on your investment. To begin with, you’ll pay more to buy a financial product with a non-essential feature. In addition, the product will cost more in yearly upkeep. To top it off, the benefit, if any, will amount to lowering the volatility of the investment. It won’t expand your return.
Worse yet, innovative investment products do sometimes “blow up in the face” (as the saying goes) of investors who have been lured by their unique appeal. That’s why we advise sticking with simple, plain-vanilla investments. You can cut volatility by diversifying and sticking with high-quality investments.
Investment concepts: ETFs have also evolved to include their own “bells & whistles”
Adding more features can make investing in ETFs attractive to a wider range of investors. However, adding features also adds profit opportunities for the sponsoring institution.
For example, consider a typical ETF that gives you exposure to an index of stocks in an emerging market. This may appeal to investors who are thinking of investing in ETFs or other stocks in that market. But conservative investors may hesitate to buy, because they worry about currency movements in the emerging market. To address that apprehension, the financial industry has come up with “hedged” ETFs.
The sales pitch is that you can profit from growth in the stock market of the emerging economy, but you avoid foreign-exchange risk because the ETF operator hedges against it. This conveniently overlooks the fact that hedging costs money.
Hedging costs will vary, depending on conditions in the foreign-exchange market, and on how an ETF carries out its hedging program. These fees can double or triple the typical 0.30% to 0.70% ETF management fee.
You’ll need to dig deep to find out how much you pay for an ETF’s hedging feature. But you can be sure that the placing of each new hedge provides a profit opportunity for the ETF sponsor.
Our view again: simple is better. If you want to invest in something like emerging-market stocks, limit your stake to a point where you can accept the associated foreign exchange risk. If you buy an ETF, choose a “plain vanilla” unhedged version.
Or, to adapt yet another old investor saying, “If the foreign-exchange risk on your emerging-market investments keeps you awake at night, sell down to the sleeping point.”
Investment concepts: Traditional ETFs provide better opportunities than many “new” ETFs
Many “new” ETFs focus on mimicking much narrower indices and higher-risk strategies, instead of giving you a low-cost way to copy the results of a standard market index. They may give you a way to invest in a particular foreign stock market—coupled with an arrangement that hedges against movements in that foreign currency. Or they may give you a way to participate in a particular stock-market strategy or a narrow niche such as solar power.
A new ETF typically carries a higher MER than an old one. Based solely on MERs, those new ETFs are still cheaper to invest in than conventional mutual funds, but many need to delve into frequent trading or derivatives of various sorts to accomplish their stated objectives.
Bonus Tip: The best investment concepts for ETFs include ones that provide broad exposure—and lower fees
Investors get the broad market exposure of a traditional mutual fund, plus the ability to trade at will with nominal fees. The best ETFs represent a low-cost, tax-efficient way for investors to make money in the long term.
The best ETFs offer well diversified, tax-efficient portfolios with exceptionally low management fees. Investors large and small use ETFs to build well-diversified portfolios.
ETFs have evolved, and competition has increased. Still, you need to be very selective with your ETF holdings
What types of “bells & whistles” have you seen investors fall for?
What kind of experience have you had with new investment concepts like hedged ETFs, for example?
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