Despite the Bad Press, ETFs are Better than Mutual Funds

When it comes to public relations, exchange-traded funds (ETFs) haven’t had it all too well. It was just more than six weeks ago that the world of ETFs suffered the embarrassment of Aug. 24. That was the day of the crazy mispricing action that resulted in some of the market’s most stable and widely held ETFs opening 25%, 35% and even nearly 50% below the prior session’s close.

A toxic combination of massive imbalances between sell orders and buy orders, the implementation of Securities and Exchange Commission (SEC) “Rule 48” that caused a lack of transparency and circuit breaker rules that halted trading for short periods added up to a public relations (PR) nightmare for ETFs.

This situation also forced us to rethink a principle that we had previously held on to for many years, and that is the principle of always putting in a stop-loss order on any position we enter.

Another likely result of the August ETF PR kerfuffle will be the bashing of ETFs as “too dangerous,” “too volatile” and “too risky” by the mutual fund industry.

Although I haven’t yet seen widespread, public bashing of ETFs happen in earnest, I do know that many traditional mutual fund advisors have been using the pricing disruption in ETFs as a tool to criticize the use of ETFs. While we still recommend mutual funds from time to time in my Successful ETF Investing newsletter, for the most part I am vehemently opposed to their widespread use.

Here are just some of the reasons why you shouldn’t be buying mutual funds (the exception here is in your 401(k)-type accounts).

1. Outrageous fees. I know there are many reasonably priced funds out there, but the number of funds that still sport extraordinarily high fees is ridiculous. Although mutual funds should be disclosing the amount of fees they’re charging in dollar terms within their statements, the mutual fund lobby has still managed to blunt any simple, transparent disclosure of such fees.
2. Exit charges and sales loads. In addition to the high management fees of 1-2% on many funds vs. expense ratios of 0.15-0.25% on similar ETFs, there also are plenty of exit fees and sales loads that never really seem to be fully explained or disclosed in a really clear manner when you redeem shares.
3. Inefficient taxation. Because mutual funds tend to have high turnover in terms of the positions bought and sold by active fund managers, investors get stuck with the tax consequences of capital gains (unlike indexed ETFs, which have little or no turnover).
4. Lack of access. Although there are many mutual funds out there, most do not invest in commodities, currencies or alternative strategies. Compared to ETFs, mutual funds do not give investors anywhere near the flexibility of ETFs when it comes to investing in single countries, single sectors, industry groups, leveraged funds, etc.
5. Lack of innovation. There hasn’t been much innovation in mutual funds these days. Since launching a new mutual fund is very expensive, and since the field is crowded already, fund companies have basically been stagnant in terms of new offerings. It’s the opposite situation for ETFs, where each year we see hundreds of new ETFs offering interesting ways to gain low-cost exposure to markets.

When it comes to ETFs vs. mutual funds, there really is no comparison for individual investors.

Are there problems with ETFs? Yes. The August mispricing incident did expose a flaw in the system during times of acute market stress. However, that incident should not be a sufficient reason to listen to the ETF naysayers — and I especially don’t want you to make the mistake of buying into the anti-ETF PR from mutual fund advocates.

Can’t Get No Satisfaction

“Man is the only animal whose desires increase as they are fed; the only animal that is never satisfied.”

— Henry George

Our increased desires often are a source of sorrow. Yet the desire for more in life — more money, more love and more success — is what leads us to develop, create and invent societal improvements. That’s why it’s a good thing that we, as Mick Jagger would say, “can’t get no satisfaction.”

Wisdom about money, investing and life can be found anywhere. If you have a good quote you’d like me to share with your fellow readers, send it to me, along with any comments, questions and suggestions you have about my audio podcast, newsletters, seminars or anything else. Ask Doug.

In case you missed it, I encourage you to read my e-letter column from last week on Eagle Daily Investor about the disappointing performance of the market in Q3. I also invite you to comment in the space provided below my commentary.