Chapter 20
Proceed-with-Caution ETFs
IN THIS CHAPTER
Learning about the pitfalls of leveraging
Understanding the mechanics of bull and bear funds
Recognizing the limits of buffer ETFs
Avoiding very narrow markets
Assuming you are reading the chapters of this book in order, you are undoubtedly by now marveling at the enormous variety of ETFs you have to choose from. Perhaps you are feeling like you have too many choices. In Part 5, I’ll give you some sample portfolios, using good, solid ETFs. Maybe that will help you winnow down your options. But this chapter should also help you, by suggesting entire categories that you don’t need to incorporate into your portfolio, and in fact, you may be better off if you don’t.
I’m going to start with a huge category, with at least 85 ETFs, according to ETF.com. These are the so-called inverse ETFs that promise you can make money when the market loses money. And they do do that…sort of.
Funds That (Supposedly) Thrive When the Market Takes a Dive
In June 2006, an outfit called ProShares introduced the first ETFs designed to short the market. That means these inverse ETFs are designed to go up as their market benchmark goes down, and vice versa. The four original ProShares inverse ETFs are the Short QQQ fund (PSQ), which is betting against the NASDAQ-100; the Short S&P500 (SH); the Short MidCap400 (MYY); and the Short Dow30 (DOG).
DOG, indeed. If I were to devise a ticker for the entire lot, it would be “HUH?”
As it happens, this HUH? category of ETFs has proliferated like no other. The original four are still around. And on top of those, you can now find many dozens of ETFs, largely from ProShares and Direxion, that will allow you to short anything and everything, including the kitchen sink (see the ProShares UltraShort Consumer Goods ETF [SZK]). From the U.S. stock market, to various industry sectors, to the stock markets of other countries, to Treasury bonds, to gold and oil, it is now easy to bet that prices are heading south.
And for the truly pessimistic investor, many of these short ETFs now allow you to bet in multiples. In other words, if the market falls, these funds promise to rise on a leveraged basis. For example, the Direxion Daily Natural Gas Related Bear 2X Shares (FCGS) is designed to rise 10 percent if the market in natural gas falls 5 percent. And the Direxion Daily Semiconductor Bear 3X Shares (SOXS) is designed to rise 30 percent if the market for semiconductor stocks falls 10 percent.
From where I sit, these funds look an awful lot like legalized gambling. If you’re considering putting your bag of nickels in any of these slots, keep reading for my two cents.
Entering an upside-down world
In other parts of this book, I talk about correlation and how wonderful it is when you can find two asset classes that go up and down at different times. Heck, it would seem that funds that short the stock-and-bond markets would be ideal additions to a portfolio. Talk about diversification! Ah, but there are hitches. For example, when you diversify, you want to find various asset classes that move out of sync but that are all expected to move upward over time, making money for you. Funds that short the stock-and-bond markets fail to meet the long-term test.
Sure, sometimes stocks decline. But over the long run, they rise. If they didn’t, you wouldn’t have a stock market. Who would invest? So over the long run, expect the short funds to lose money. Just about the only way to make money with these funds is to time the market just right: to jump in just as the market is about to dive and then pull out before the market goes up. Good luck! Market timing, I’m not the first to say, is a fool’s game.
Here’s another hitch: These short ETFs are designed to move against the market on a daily basis. That means if the market goes down 5 percent on Wednesday, your fund should go up 5 percent (or, if your fund is leveraged, 10 percent or 15 percent) on Wednesday. But the mathematics of this, as I show you in the upcoming section, “Funds That Double the Thrill of Investing (for Better or Worse),” is very tricky. This tricky math means that if you invest in these funds for more than a very brief spell, you are practically destined to lose money, regardless of which way the market moves!
Boasting a track record like none other
Don’t take my word for anything I stated in the previous section. Just check the long-term performance records of these beasts. All of the original ProShares inverse ETFs introduced in 2006 have been proudly torturing investors ever since. The ProShares Short QQQ (PSQ), for example, has lost 17.9 percent annually since inception. The ProShares Short S&P500 fund (SH) has lost 12.3 percent a year since inception. The Short Dow30 (DOG) has lost 11.9 percent since inception. Bow-wow. That’s –17.9, –12.3, and –11.9 percent per year. In other words, investors from the start have but pennies in place of their original dollars.
And those pennies would seem like manna from heaven if you had invested in Direxion’s Daily S&P 500 High Beta Bull 3X Shares (HIBS), one of Direxion’s many, many “Bear 3X” funds that promise you $3 on any day that the S&P 500 loses $1. (Of course, on days the S&P 500 gains $1, you would lose $3.) HIBS began in November of 2019. By August of 2021, a little more than a year and a half later, it had lost 88.2 percent of its value.
Sure, the stock market could tumble at any time, and you could profit by buying inverse or short funds. But you will need to time that stock market tumble just right, and the odds of doing so are very slim. Moreover, to play this stacked game will cost you: None of the short ETFs charge less than 0.75 percent, and most carry expense ratios of about 1 percent, making them among the most expensive ETFs on the market.
Before leaving this section, I just want to state that I do not by any means want to demonize either ProShares or Direxion for their inverse funds. These funds do exactly what the companies say they will do. You will indeed get the inverse of the daily return for whatever index the ETF is tracking, and if you wish, you can double- or triple-leverage your investment. I’m not saying these funds serve no purpose or are in any way evil. They work. And they undoubtedly serve a purpose for certain investors, perhaps professional traders and institutions that need short-term hedges. All I’m saying is that they do not make good long-term holdings for the average investor — for you or me.
Funds That Double the Thrill of Investing (for Better or Worse)
ProShares introduced four other ETFs in 2006 along with its inverse funds. These other funds targeted investors at the other end of the sentiment spectrum: extreme optimists. These were leveraged funds that included the Ultra QQQ (QLD), which sought “daily investment results, before fees and expenses, that correspond to twice (200%) the daily performance of the NASDAQ-100 Index,” and the similarly designed Ultra S&P500 (SSO), Ultra MidCap400 (MVV), and Ultra Dow30 (DDM).
Since that time, ProShares, Direxion, and a handful of other ETF providers have introduced many dozens of leveraged ETFs. You can currently find 125 leveraged ETFs listed on ETF.com. These ETFs allow you to hypothetically double or triple your daily return (or loss) on just about any segment of the market you choose. Just like the inverse ETFs, these ones do exactly what they are supposed to do. And because markets tend to go up over time, these leveraged funds do make more sense than the inverse funds. I must, however, recommend caution.
You think the market at large is going to rock? These funds, which use futures and other derivatives to magnify market returns, promise to make you twice or triple the money you would make by simply investing in the NASDAQ-100, the S&P 500, the S&P MidCap 400, the Dow, or any number of other indexes tracking anything from consumer staple stocks to real estate to Treasury bonds to the price of oil. Of course, you’ll have to accept twice the volatility. It seems like it might be a fair bet. But it really isn’t.
Crazy math: Comparing leveraged funds to traditional ETFs
Suppose you invest in the Ultra S&P500 (SSO), as opposed to, say, the SPDR S&P 500 (SPY). On a daily basis, if the underlying index goes up, your investment will go up twice as much. If the underlying index goes down, your investment will go down twice as much. Clearly the volatility is double. But let’s look at the potential returns, as well.
The SPY is going to cost you 0.09 percent in operating expenses. The SSO is going to cost you 0.91 percent. That’s a difference of 0.82 percent a year, or $410 on a $50,000 investment. You can expect about 1.4 percent in annualized dividends on SPY. Because SSO invests largely in derivatives, you aren’t going to get much in dividends — expect a yield of about 0.16 percent. On a $50,000 investment, that’s a difference of an additional $650. Already, you’ve lost $1,060 ($410 + $650), regardless of which way the market goes.
But it isn’t actually the loss of dividends or the high operating expenses that will hurt you the most with leveraged funds. It’s more the added volatility — daily volatility — that will eat up your principal regardless of which way the market goes.
Follow closely:
Suppose you invest $1,000 in SOO, which seeks a return of 200 percent of the return of the S&P 500 Index. Now suppose that the index goes up 10 percent tomorrow but then drops 10 percent the day after tomorrow. You think you’re back to $1,000? Guess again. The math of compounding is such that, even if you had invested in the index itself — unleveraged — you’d be in the hole after Day Two. Run the numbers: Your 10 percent gain on Day One would take you up to $1,100, but your loss of 10 percent of $1,100 the next day equals $110. Subtract that amount from $1,100, and you’re left with $990 on Day Two, or an overall loss of 1 percent.
With SSO, you’re going to get double socked. On Day One, you’ll happily be up 20 percent to $1,200. But on Day Two, you’ll lose 20 percent of that amount and find yourself with $960. You didn’t lose the promised double (2 percent); you just lost quadruple (4 percent). Pull out your calculator if you don’t believe me.
In a classic illustration of the principle that life is not fair, you are not helped if the market goes down and then up, instead of the other way around. Lose 10 percent of $1,000, and you’ve got $900. Gain 10 percent the next day, and what do you have? $990 ($900 + $90). The situation is magnified with SSO: You would lose 20 percent on Day One for a balance of $800 and gain 20 percent on Day Two to bring you right back to the same $960 you were left with in the first example.
And that, dear reader, is how these funds can nibble at your hard-earned savings, and why I suggest that you do not use them… .Even though, in periods of low volatility and a strong market, leveraged bull funds can make you good money.
The continuing sad saga of DIG and DUG
In the end, how have leveraged funds done? Again using the ProShares Ultra S&P500 ETF (SSO) as a case study, it has returned 15.0 percent annually since inception through June 30, 2021. That compares to 10.7 percent for the S&P 500 during the same period. In other words, with SSO, you got 140 percent of the return with 200 percent of the risk of the S&P 500. That’s no great shakes.
Had the stock market gone the other way… . Wait! It actually did go the other way for energy stocks, which have had a very rough several years now. Lo and behold, the ProShares Ultra Oil & Gas ETF (DIG), which doubles your daily return of the index, has had a miserable five years, with an average annual return of –15.3 percent. Maybe you should’ve invested five years ago in the ProShares Ultrashort Oil & Gas (DUG), which doubles your money in the other direction — going up when the stocks go down? Um, no… . That fund would have returned –24.5 percent a year over the past five years.
Think hard before investing in leveraged ETFs, please.
“Buffer” or “Defined-Outcome” ETFs
In 2018, a company called Innovator came up with an idea to introduce an entirely new class of ETF. This kind of ETF would be everything that most ETFs are not: actively managed, expensive, and extremely complicated. Despite all this, they sold like hotcakes, and there are now, according to ETF.com, about 130 of them. Innovation is still the leader, but they’ve been joined by First Trust, TrueShares, Nationwide, and a handful of others. What explains their popularity? They offer what variable annuities have long offered: a chance to make money in the markets with limited risk.
The “defined-outcome” or “buffer” ETFs work in any number of ways. But basically, the issuing company promises to protect you from loss — to provide a floor in case the markets go south. To compensate the company for giving you this protection, you agree to share your gains when the market heads north. That’s it in a nutshell. But there are holes in the floor, and the gains you’ll be sharing aren’t insignificant. Oh, and then there are the high fees on top of it all.
Let’s take a look at just one of these defined-outcome ETFs. I’m choosing Innovator’s S&P 500 Buffer ETF (BJUL), which was one of the first. It opened its doors to investors on August 29, 2018. The fee is 0.79 percent. It doesn’t hold any actual stocks, but uses derivatives to track the S&P 500 Index. The fund returns more or less what the index returns, minus the expense ratio. But unlike an investment in a typical S&P 500 fund, you are protected if the S&P 500 drops as much as 9 percent over the course of a year. If the S&P 500 drops 1 percent, or 5 percent, or 9 percent, you will lose nothing. If, however, the S&P drops more than 9 percent, you will lose. If the S&P drops 10 percent, you will still lose 1 percent. If the S&P 500 drops 29 percent, you will lose 20 percent. And on the flip side, you will earn whatever the S&P earns over the course of the year, up to 12 percent. If the S&P returns, say, 10 percent, you will get 10 percent. If it rises by 12 percent, you will get 12 percent. But if the S&P rises by 32 percent, you will still only get 12 percent. You won’t see the other 20 percent.
And that’s pretty much how all buffer funds work. They track different indexes, and they have different floors and ceilings, but they all offer some buffer and cap.
BJUL, since inception, has returned 7.5 percent to investors. Had they invested in an S&P 500 fund, they would’ve earned about 14.9 percent over the same period. But, of course, investors in BJUL took less risk, so it would be unfair to put BJUL head to head with the S&P 500. What it more deservedly should be compared to is a diversified stock-and-bond portfolio. Don’t want the risk of the S&P 500? You’re willing to give up some return? Then invest half your money in stocks and half in bonds. Instead of 0.79 percent in management fees, pay 0.05 percent. In the long run, you are almost certainly going to do better.
That being said, these buffer ETFs are a great improvement over the variable annuities that people bought before to buffer their portfolios! The expense ratio of 0.79 percent is peanuts compared to what some variable-annuity contracts cost, and there are no noxious surrender-fee periods that lock you into your investment, even long after you’ve discovered how bad it is.
Alphabet Soup: MLPs, SPACs, and IPOs
There are so many ways to slice and dice a portfolio these days. There are domestic stocks and foreign stocks, large caps and small caps, value and growth, Treasuries and corporate and municipal bonds, long-term bonds and short-term bonds, and the list goes on and on. At some point, it is easy to find yourself with an unwieldy portfolio. There’s nothing wrong per se with investing in oddball asset classes, but you really don’t need them. And please, realize that these oddball asset classes tend to be very faddish. You’ll hear people swear that you can’t lose money with MLP, SPAC, or IPO ETFs, depending on the given day.
MLP ETFs invest in companies structured as master limited partnerships. These are firms that usually derive their income from exploration for and extraction and refinement of oil and gas. Examples include the First Trust North American Energy Infrastructure Fund (EMLP), the Global X MLP & Energy Infrastructure ETF (MLPX), and the Tortoise North American Pipeline Fund (TPYP). They have cost ratios of 0.96 percent, 0.45 percent, and 0.40 percent, respectively. They have all seen very lackluster performances over the past several years. As we look ahead, no one can say what will happen. Invest if you like, but you don’t need this in your portfolio. Most broad stock indexes offer you plenty of energy stocks.
Want to take a real joyride? Try initial public offerings. In April 2006, First Trust Advisors introduced the First Trust IPOX-100 Index Fund (FPX). You can invest in an ETF that, according to the prospectus, tracks the 100 “largest, typically best performing, and most liquid initial public offerings” in the United States. The fund changed its name and is now called the First Trust US Equity Opportunities ETF. It charges 0.57 percent, is passively run, and has a performance record of 13.8 percent a year since inception, versus the S&P 500, which has returned 10.5 percent during the same period. But FPX is a heck of a lot more volatile. So, too, is the First Trust International Equity Opportunities ETF (FPXI), with an expense ratio of 0.70 percent, and a performance record of 14.35 percent annual return since inception in July 2014, versus 6.5 percent for the MSCI World ex USA Index. A firm called Renaissance has both a domestic and a foreign IPO ETF to compete with First Trust. The tickers for the Renaissance funds are IPO (for the domestic) and IPOX (for the foreign). Invest if you will, but keep your exposure light. If there’s a recession, these IPOs will get crushed.
SPAC ETFs invest in special acquisition companies, companies that are formed not to produce anything, but to find deals, such as other companies to buy or merge with. SPACs are a special kind of IPO. The SPAC and New Issue ETF (SPCX) charges 0.95 percent but promises to offer you exposure to “one of the most exciting and disruptive capital markets themes over the past several years.” (Everything is “disruptive” these days!) The Indxx [sic] SPAC & NextGen IPO Index (SPAK) charges 0.45 percent and also promises “disruption”! Then there’s the Morgan Creek-Exos SPAC Originated ETF, which charges 1.0 percent. None of these funds have been around long enough to have much of a track record.
Investing in one-horse towns
There is almost no limit to how many moving pieces you can have in a portfolio. Let’s see…you can purchase an ETF such as the Vanguard Total World Stock ETF (VT) and — voilà — with but one moving piece, you own shares in 9,105 stocks from nearly every country. Or, if that’s too broad, you can split your holdings into the Vanguard Total (U.S.) Stock Market Index Fund (VTI) and the Vanguard Total International Stock Index Fund (VXUS) — two pieces. If that’s still too broad, you can find ETFs to break these up by style (large, small, value, growth) or industry groupings (energy, REITs, health care, technology, consumer staples, utilities, and so on). If that’s too broad, you can break up your international holdings into Pacific and Europe, or developed markets and emerging markets. All of this is sane and rational.
But you can also take it too far. You can divide your industry-sector ETFs into subsectors. Instead of buying “technology,” you can buy a Cloud computing ETF, along with an artificial intelligence ETF, along with a robotics ETF, and a lithium and battery ETF. Instead of buying “real estate” or “REITs,” you can buy ETFs filled with mortgage REITs, residential REITs, high-dividend-paying REITs, industrial REITs, and corporate real estate. Instead of buying a broad commodity fund, you can buy ETFs that give you exposure to a single commodity, be it oil, platinum, palladium, uranium, wheat, soybeans, corn, sugar, or livestock.
Instead of buying an emerging-markets ETF, or a frontier markets ETF, you can buy ETFs that track the stock markets of individual countries. There’s one for Nigeria, another for Columbia, and one for Pakistan. And before you know it, you have 100 moving parts in your portfolio, and you’re getting monthly statements from your broker that are way longer than CVS receipts.
You may think that, say, Nigerian stocks will outperform other emerging-and-frontier-market stocks. But do you really want to put a sizeable portion of your portfolio into a group of stocks that altogether have a capitalization of $49 billion? That’s less than you’d find in Jeff Bezos’s right pocket on a Saturday afternoon. You may think that residential REITs will do better than industrial. You may think that wheat futures will do better than corn. But how many holdings are you going to have? And at some point, you do realize that you’ll own everything anyway, right? Why not just buy a total-market fund?
Sure, you say, but still, it might be worth a flyer to invest just 2 percent of your portfolio in whatever asset class. You can do that. But, really, if Nigerian stocks fly next year, if wheat flies, or palladium, will it make much difference in your portfolio if only 2 cents of every dollar is invested in each of these market slivers? I’d say, as a general rule, you might have 6 to as many as 25 ETFs, maybe 30 in a very large portfolio. Tops. Anything beyond that is just kind of crazy…and it will drag your portfolio down, because ETFs that track small slivers of the market are never cheap. Here are some example costs:
- Vanguard’s Total World Stock ETF (VT) will cost you 0.08 percent, whereas the Global X MSCI Nigeria ETF (NGE) will cost you 11x as much: 0.89 percent.
- The Vanguard Information Technology ETF will cost you 0.10 percent, whereas the Global X Cloud Computing ETF (CLOU) will cost you 0.68 percent.
- The Schwab U.S. REIT ETF (SCHH) will cost you 0.07 percent, whereas the VanEck Vectors Mortgage REIT Income ETF will cost you 0.40 percent.
I’d also say that most people who buy very narrow ETFs tend to trade them frequently. ETF day trading has taken the place of stock day trading. And day traders of all kinds tend to eventually lose their shirts. They forget that every time they buy or sell, there’s a professional on the other end of the deal, and they’re selling when you’re buying for a good reason.
Get Rich (or Not) in Crypto- or Other Currencies!
One group of “sliver” ETFs worth special mention is just now seeing the light of day. I’m talking about the cryptocurrency ETFs. Dozens of firms have put in applications with the SEC to release Bitcoin and other cryptocurrency funds. Just as this book was going to press, on October 19, 2021, ProShares, with SEC approval, introduced the ProShares Bitcoin Strategy ETF (BITO).
Like putting money into Bitcoin itself, this is more speculation than investment. Cryptocurrencies do not pay dividends or earn profits. In fact, they cost quite a bit to store (in both financial and environmental terms). You might get lucky, and make a fortune. You might lose everything. There are plenty of people already in both camps.
Investing in non-cryptocurrencies is also more like gambling than investing. Through Invesco CurrencyShares, you can buy ETFs that will give you exposure to the Australian dollar, the euro, or the Canadian dollar. Through WisdomTree or ProShares, you can not only invest in foreign currencies, but also leverage them with bull or bear funds, such as the ProShares UltraShort Yen ETF (YCS). For 0.95 percent a year, you can buy a contract that’ll earn you two times the inverse (–2x) of the daily performance of the Japanese yen versus the U.S. dollar. Since inception in November 2008, this fund has returned 0.10 percent per year. Had you bet that the Japanese yen was going to go up vis-à-vis the U.S. dollar, you could’ve plunked your money into the ProShares Ultra Yen ETF (YCL), which would’ve earned you two times (2x) the daily performance of the price of the Japanese yen versus the U.S. dollar. This fund also charges 0.95 percent. Since inception in November 2008, YCL has lost an average of –5.2 percent a year. Either way, betting on the yen or against it, on a $10,000 investment, you would’ve paid ProShares (13 x $95) about $1,235 in fees since 2008.
Currencies, whether real or crypto, are generally not good investments. They fall more under the umbrella of speculation.
By the way, according to my fancy financial calculator, starting off with the $10,000 investment, and losing an average of –5.2 percent a year for 13 years should leave you with $4,995, for a cumulative return of –50 percent. But that’s just a rough figure. For the exact cumulative return, you’d have to go to the ProShares website. But wait! It isn’t there. At least, I can’t find it. (Not to pick on ProShares, because many, if not most, fund companies pull this little trick.) If a fund has done very well, you’ll find the cumulative return right next to the average annual return. If a fund has done poorly, you’ll have to search through the site to find the cumulative return, and often you won’t. Yeah, I find it annoying.
Take a Whiff of These Cannabis ETFs
I had the good fortune several years ago of spending time in the beautiful city of Amsterdam. I was staying with a friend who had a 19-year-old son, and one day the son had a large group of friends over to the house. Mind you, this is the Netherlands, a country where marijuana has been legal and easy to obtain for many, many years. I asked the young Dutch people assembled if they smoked pot. Not only did none of them respond in the affirmative, but only one out of half a dozen had even tried pot! They saw my surprise. “When your parents do it, it isn’t cool,” one young woman volunteered.
As various states (and all of Canada) have legalized pot, and more states are following suit, American investors have been assuming that pot consumption will soar and that there’s lots of money to be made. And me? I keep thinking of that day in Amsterdam.
Recreational pot consumption may take off, or it may not. Medical marijuana use is almost certain to grow, but it remains to be seen just how profitable this new industry will be. Meanwhile, there are no fewer than eight marijuana ETFs. The Cambria Cannabis ETF (TOKE) is the least expensive with a net management fee of 0.42 percent. Most of the others are 0.75 percent or more. TOKE is actively managed and holds 27 stocks from the U.S., Canada, and overseas. It was founded in July 2019, and in its first two years, has lost 21 percent of its value. The second-least expensive is the Global X Cannabis ETF (POTX), with an expense ratio of 0.51 percent. It was founded in September 2019, and in not quite two years, it’s lost 24.5 percent of its initial value.
Reflecting back to my college days, if I really thought that marijuana was going to take off, I think I’d try to invest in chocolate chip cookies.
Copycat ETFs
ETFs are unlike snowflakes. You can indeed find two, or three, or more that are exactly alike. If you are looking at two passively run funds that track the same index, then you are looking at identical investments, for all intents and purposes. In this section, I mention four such funds, all of which track the S&P 500 Index. I’m using these ETFs to illustrate that you’ll usually just want to pick the one with the lowest expense ratio. Consider the higher-priced ETFs mere copycats, best to be left alone. You don’t need to toss money to the wind.
But there are a few exceptions to that rule, times when choosing the least expensive option may not be the best bet. I’ve come up with four such exceptions, which I’ll cover at the end.
SPDR S&P 500 ETF Trust (SPY)
Inception date: January 22, 1993
Management fee: 0.0945 percent
Performance: 10-year return of 14.68
SPDR Portfolio S&P 500 ETF (SPLG)
Inception date: November 8, 2005
Management fee: 0.03 percent
Performance: 10-year return of 14.68
iShares Core S&P 500 ETF (IVV)
Inception date: May 15, 2000
Management fee: 0.03 percent
Performance: 10-year return of 14.78
Vanguard S&P 500 ETF (VOO)
Inception date: September 7, 2010
Management fee: 0.03
Performance: 10-year return of 14.80
Which one would you choose if you wanted an S&P 500 ETF? That’s easy: Any of the three with the 0.03 percent expense ratio. Why not Vanguard’s ETF, with its slightly higher return? That’s only because Vanguard was the original cost-cutter, so the slight difference in return is due to lower expenses over the past 10 years. Moving forward, that advantage is gone (unless Vanguard cuts its costs even more).
Why would anyone not choose the less expensive funds and instead go with SPY?
Some people are just lazy, and don’t shop around enough. But there are also some logical reasons to sometimes go with a more expensive fund. I can think of five such reasons.
- Liquidity: If you are a day trader, you need a fund with super liquidity. Even a fraction of a second’s delay in making a trade, or an extra penny going to the middlemen for a $1 million trade, will add up over time. In this case, you might choose SPY, even though the management fee is more than three times that of the others. For the buy-and-hold investor, the extra penny here and there lost on a trade won’t matter a whit.
- Avoidance of capital gains: If you already have SPY in your portfolio, and you’ve had it for many years, there may be a huge capital gains tax to pay if you cash out. Although capital gains must be paid to Uncle Sam sooner or later, sometimes it just makes sense to wait.
- Avoiding commissions: Not long ago, you could trade Vanguard ETFs free if you had a Vanguard account. Trading other ETFs would cost you some money. But these days, at most brokerage houses, trading ETFs costs nothing. And it doesn’t matter what brand of ETF you are using. Still, I’m throwing this out here in case you are with a brokerage that still charges.
- Shunning rookies: If there’s a new ETF on the market, issued by a small provider, and the fund has collected less than, oh, $20 million or so, you risk having the ETF fold. Yes, you’ll get your money back if that happens, but it’s a hassle you should avoid.
- Sustainable considerations: One fund I didn’t mention here is the Engine No. 1 Transform 500 ETF (VOTE). I introduce this fund in Chapter 17 on sustainable investments. The fund charges 0.05 percent. The portfolio isn’t exactly the S&P 500, but pretty darned close. In this case, paying the extra 0.02 more than you’d pay for the Vanguard or iShares S&P ETF isn’t illogical at all. You are paying that extra (20 cents per $1,000 invested) so that the managers of the fund will use their muscle to try to convince companies to act in a kinder and gentler manner where people and planet are concerned. Neither the 20 cents per $1,000 nor the slight differences in portfolio composition are going to much affect your bottom line.