Aaron Katsman 58.
(photo credit: Courtesy)
If you are an investor, there is a good chance you have heard about Exchange
Traded Funds. ETFs have become the fastest growing financial tool used by
investors. The financial media are full of advice for individual
investors on how to use ETFs to create well-diversified investment portfolios.
Despite all the attention they get and their surging popularity, many investors
don’t really understand what they are and how they are meant to be
ETFs are defined as “securities that track an index, a commodity or
a basket of assets like an index fund, but trade like a stock on an exchange,
thus experiencing price changes throughout the day as they are bought and
In other words, an ETF is a security that tracks some kind of
stock or bond index and allows the investor to track that specific index closely
through buying this one particular product.
For example, if an investor
wants exposure to the S&P 500 stock index, he can either buy all 500 stocks,
which would be very costly and time consuming, or he can purchase an ETF. The
ETF will track the S&P index nearly point for point. Due to their low costs
and simplicity, many investors are very keen to buy ETFs.OVERKILL?
first ETF was launched on the Toronto Stock Exchange some 20 years ago, and they
have been a huge success ever since. Over the past five years, there has been an
explosion of new ETFs, with hundreds of products hitting the market, leaving
investors scratching their heads trying to figure out which ETF is a good fit
for their portfolio. As ETFs have gained in popularity there is now one for
almost every index under the sun. My favorite is an ETF that specializes
in metabolic endocrines – whatever that is!
There are now “inverse ETFs,” which
are a way to make money when the market drops. Leveraged ETFs have become hugely
popular, especially among day traders, as they enable investors to get up to
three times the leverage on a particular index. There are also a slew of ETFs in
registration that will track particular hedge-fund strategies and even actively
Due to a lack of interest, many of these very innovative
ETFs have had to close down. But there are still hundreds left in the market.
With this burgeoning industry coming up with all kinds of new and innovative
products, ETFs appear to have moved away from their initial role of allowing
investors linkage to a broad market index. Instead, they are leading investors
into a false sense of security that they are indeed diversified, when in fact
they are far from holding a well-diversified portfolio.
are many advantages to purchasing ETFs. First and foremost is diversification.
By definition, ETFs give the investor potential exposure to hundreds, if not
thousands, of stocks, providing a welldiversified global portfolio, while
investing passively without having to track a myriad of
securities. Another benefit is liquidity. Because they trade like
individual stocks, ETFs can be bought and sold throughout the trading day,
allowing active traders to try and time the market and cash in on intraday
market moves.MANAGED PORTFOLIO
How can an investor capture the
advantages of these products while trying to wade through all the minutiae out
there? More and more financial advisers have begun offering “Core ETF”
portfolios. The idea is that these portfolios are globally diversified using
basic ETFs. However, they follow mathematical models that help the investor
obtain a welldiversified portfolio, while limiting some of the volatility that
comes with investing.
This creates the benefit of being linked to many
stock indices, with the knowledge that the most appropriate ETFs are being used.
In this case, the client does not need to worry about which ETF to
use. Rather, he relies upon the analysis and expertise of advisers who
specialize in this particular field.
Many investors find ETFs useful in
building their portfolio. Be aware, however, that when you look at their
results, past performance does not guarantee future returns. It may be
worthwhile asking your investment adviser if ETFs can be used to diversify your
portfolio in a low-cost, efficient manner.
Aaron Katsman, a licensed financial adviser in Israel and the United States,
helps people with US investment accounts.