Exchange Traded Funds (ETFs) are a form of investment security that tracks an index, commodity, asset class or basket of company stocks and can be traded on the stock exchange like a normal stock.
There are many ETFs in the markets that allow investors to gain a foothold into the world of investment, through flexible trading, portfolio diversification, proper risk management, low costs and tax savings.
Vanguard S&P 500 ETF (VOO) tracks the performance of S&P 500 by replicating the index through investing all of its assets in the stocks that make up index at the same approximate weightings as the index. Its top holdings include the likes of Apple Inc., Microsoft Corp, Amazon.com Inc., Facebook Inc., Alphabet Inc., Tesla Inc., Berkshire Hathaway Inc., NVIDEA Corp and so on.
Investco QQQ Trust (QQQ) tracks the NASDAQ-100 index by investing in a portfolio of 100 largest non-financial stocks listed on the NASDAQ and weights them by market cap. Its allocation to technology stocks is 48% and and communication stocks is 20%.
Vanguard High Dividend Yield ETF attempts to replicate the FTSE High Dividend Yield Index by investing substantially all of its assets in the high yield stocks that make up the index, including the likes of JP Morgan Chase & Co., Johnson & Johnson, Procter & Gamble Co., Bank Of America Corp., Comcast Corp., Exxon Mobile Corp., Pfizer Inc., Cisco Systems Inc. and so on.
Since ETFs offer great simplicity into the world of investing, provides instant diversification, liquidity, tax benefits, sector investing, great risk management, why am I not in favour of investing through such an investment vehicle?
Let me share on 5 reasons why.
1. ETFs are like gift hampers
ETFs are packaged nicely like a basket of a gift hamper, offering us the convenience to purchase a variety of goodies as gifts. It can contain cans of abalones, premium mushrooms but are usually filled up by other biscuits and chocolates which are merely fillers to make up the numbers. I may only like abalones and premium mushrooms but will be forced to take up chocolates, sweets and cookies that I do not like. Hence while it is easy to purchase the basket of gift hamper, we could not customise the items inside to fit our preferences.
ETFs usually own all the companies stock in an index or a sector and are overly diversified. We may just want to own the very best stocks and not the other under performing companies stocks.
Many fund managers of ETFs do not regularly adjust or rebalance the portfolio such that they sell high performing stocks to switch into underperforming ones which offer more value. As the fund needs to mimic the index or sector that it tracks, there is restriction and rigidity in terms of allocation ratios.
2. Hidden costs
The fund manager or institution which manages the ETF does not perform the job for free. Management fees are involved and investors should look at the expense ratio of the specific ETFs which they want to invest in. Expense ratio typically range from 0.2% to 0.6% for ETFs and investors may end up paying more than what the portfolio would cost if they would to invest in individual stocks themselves through low cost trading platforms.
Annual expense costs of an ETF are hidden, complicated and can be associated with all the operating costs to maintain the fund, such as marketing, accounting, legal, salaries of fund board of directors, custodial costs, interest-related charges. These costs are on top of the typical commissions and trading charges we incur upon buying the ETF from the stock market.
I believe the total costs of investing in ETFs can erode the greater potential gains which can be reaped if we were to pick and concentrate on fewer high-quality, performing stocks to invest.
3. Lazy way of investing
Investing in ETFs is a passive form of investing since ETFs offer great convenience and simplicity in "owning" a myriad of company stocks. To me, this is a lazy way of investing. Investors would tend to neglect the tracking of the performance of companies in the ETF portfolio and just regularly dollar-cost average into the ETFs without thinking.
While a lot of effort can be saved through investing in ETFs, I believe that seasoned investors who are passionate about making their hard-earned cash grow, should really spend time to research on the businesses and companies that they are vested in, and actively adjust or rebalance their own investment portfolios.
4. Indirect ownership of businesses
Being vested in an ETF does not give us direct ownership of the businesses, companies or Reits in the fund as shareholders of an ETF do not have voting rights in the AGMs. The fund manager, or financial institution will be the rightful custodian and owner of the company shares.
If we want to feel like a boss, or major stakeholder through owning a substantial volume of a company shares, then we should invest directly by buying the company's shares.
5. Risks can be higher than we think
As all the stocks in the ETFs either belong to an index, sector or a common trait, their share price movements correlate each other. If there is a stock market crash, the indexes will reflect the crash and such index mimicking ETFs will perform accordingly due to the similar weightage of stocks in the fund. If there is an interest rate hike, high dividend tracking ETFs will tank accordingly due to its composite of all high dividend yielding stocks in its portfolio.
Take for example, the share price of Lion-OCBC Hang Seng Tech ETF (HST.SI) has tanked from the highs of $1.80 in Feb 2021 to around $1 in Aug 2021 due to the recent meltdown of China tech giants.
Investors could be better off building a more diversified portfolio with lower volatility comprising of company stocks from varied sectors and industries than a basket of stocks from the same sector or industry.
Conclusion
With the growing popularity and proliferation of ETFs, the decision on whether to invest in ETFs is subjective and differs among individual investors because it depends on many factors such as risk appetite, investment objective, horizon, sector or industry preference and degree of complementary with existing investments.
Thanks for reading. As always, stay safe and remain strong.
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