Not All ETFs Are Created Equal

Do Your Research Before Investing

Not All ETFs Are Created Equal
February 15, 2016

An exchange-traded fund (ETF) is a hybrid of stocks and indexed mutual funds. They are purchased through brokers and traded through exchanges just as a stock would be, but they represent a basket of holdings designed to track a particular index or price. The underlying asset could be stocks, bonds, commodity contracts, real estate, precious metals, or combinations of assets.

ETFs are useful to assemble a diversified portfolio at a relatively low cost. However, not all ETFs are the same, and the wrong choices could cost you significant money. Consider these factors as you review your ETF options.

  • Fee Structures – In general, ETFs have favorable fee structures, but low fees are not guaranteed. Expense ratios can be deceptively high, approaching that of a corresponding index fund. If that is the case and you do not need the trading convenience, the index fund may be a better choice. If you find index funds that track the same index but have different fee structures, look very closely to see what you are getting for your money.
  • Active Vs. Passive Management – ETF funds can be either actively managed with managers making trades in the underlying assets to meet or exceed the desired index, or be passively managed by an algorithm approach with limited intervention. Higher levels of management require higher fees.

Look at the performance of any ETF to determine whether the extra fees are paying off in greater performance. More hands-on management does not guarantee better performance — in fact, passively managed funds can often beat actively managed funds, especially in a rising economy.

  • Liquidity – Size does not matter with an ETF once it gets beyond a certain threshold, but it is difficult for an ETF to operate with low liquidity. There will be a risk premium and a higher price built into the ETF, and it may be more difficult to trade.
  • Taxes – Understand the tax implications of your ETF, because it is not always straightforward. Taxes generally relate to the underlying holdings and not the fund itself. For example, a gold ETF that invests in physical gold bars will be taxed as a collectible and not at the lower capital gains rate, even though you held it for over a year and sold it as if it were a stock.
  • Higher Risk ETFs – Leveraged ETFs are considerably higher risk than the average ETF. As with leveraged stock purchases, you are multiplying the effect of the results whether they are gains or losses. Inverse ETFs effectively bet against the rise of value of an index, so returns increase as the index declines. Both vehicles are highly speculative and tend to have high fees due to active management.

There is no harm in investing in these as long as you understand the risk and speculative nature, but you should at least ask if other higher risk investments are better for your portfolio balance.

Regardless of the ETFs you have, avoid the temptation to trade them excessively. Generally, that just racks up excessive fees and charges — and avoiding those is one of the reasons to invest in ETFs in the first place.

Several websites contain tools to help you screen and evaluate ETFs, such as with their online ETF screener. Do not go on the name alone. For example, an ETF with "oil" in the name does not necessarily track crude oil prices. It may track other parts of the oil supply chain and distribution, or equipment manufacturers that supply the oil industry.

ETFs can be excellent low-cost investments, or they can be disproportionately expensive money drains. Do your homework on any ETFs you want to invest in so you will be able to spot the difference.

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Sarah | 10.01.15 @ 14:32
Great breakdown of the various types. Very informative.
George | 10.01.15 @ 14:33
Good information.
Erin | 10.01.15 @ 14:34
Great tips and lots of information. This is helping people become smarter investors. Thanks!
Chrisitna | 10.01.15 @ 14:34
I've really got to start doing more research into investments - this is really helpful!
Steffanie | 10.01.15 @ 14:40
This is some great information that i had no idea about.
Christina | 10.01.15 @ 14:40
This is helpful. Sounds like a lot is risky.
Kamie | 10.01.15 @ 14:41
That is something I do not think I will ever want to even mess with, with my luck I would do something wrong.
Kathryn | 10.01.15 @ 14:43
I actually had never heard of this until today, this is very interesting and I would like to hear more about it. :)
Nancy | 10.01.15 @ 14:43
I never knew the difference between ETFs and regular stocks. The breakdown helped clarify it all for me.
Beverly | 10.01.15 @ 14:44
I've not really understood ETF's, so this was a good article to learn from.
Daniel | 10.01.15 @ 14:45
Seems there is always more behind the scenes worth learning about stuff i thought i knew
Elaine | 10.01.15 @ 14:50
Never heard of ETFs before, so this was very informative.
trish | 10.01.15 @ 14:58
Great tips especially for a beginner like me!
Heather | 10.01.15 @ 14:59
This is great information to have for the beginning investor. I had no idea what this was before now.
Angie | 10.01.15 @ 14:59
Thank you for providing the link to further educate ourselves on these - I had not even heard of them.
Bobbie | 10.01.15 @ 15:01
So much information to sort though, but a good guideline to get started.
Jill | 10.01.15 @ 15:08
Wonderful Info to share with friends and family!
Ron | 10.01.15 @ 15:10
Now, this is a good write up about ETF's. I was burned by one last because I simply didn't do my due diligence in research, which is a part of Money 101.
STOKES | 10.01.15 @ 15:11
Great information on something I didn't even know existed before.
Britt | 10.01.15 @ 15:23
This has a lot of great info
Clarissa | 10.01.15 @ 15:29
I have never heard of this before. I would like to read some more information on it.
Amanda | 10.01.15 @ 15:30
Good information to start looking at. Thanks
Alec | 10.01.15 @ 15:30
I'd never heard of ETFs before. It seems like it would be a "safer" alternative to regular stocks, provided you do your research first. It sounds a little more complicated but it also seems like it would be worth it.
Sara | 10.01.15 @ 15:35
Great information and breakdown of EFTs. Do not think I want to mess with EFTs though.
gracie | 10.01.15 @ 16:04
Nice breakdown of the details it was good info to be more informed about.
Carla | 10.01.15 @ 16:08
Nice breakdown of ETFs. Thanks for making it a little less complicated for me.
Jennifer Sears | 10.01.15 @ 16:12
I'm always too cautious for investments.
Chelsey | 10.01.15 @ 16:20
This is a lot of good info packed into an article. My husband and I are paying off the last of our debt, and next step is investing more.
steven | 10.01.15 @ 16:21
I think I will stay away from EFTs. Great information though.
Selena | 10.01.15 @ 16:37
Great tips for becoming a smart investor.
irene | 10.01.15 @ 16:37
I never knew what an exchange-traded fund meant before, thanks for the great explanation
Meredith L | 10.01.15 @ 16:44
Like Sarah says, this is a great breakdown of info. ETFs have always been a little bit beyond me but this has been very helpful in knowing what to look for.
$commenter.renderDisplayableName() | 05.18.21 @ 07:23