Nadig: The ETF Paradox Starts With You

February 13, 2018

As I write this, I’m headed for the big InsideETFs conference in Hollywood, Florida—easily the biggest and best ETF event every year. Inevitably, I’ll learn a lot. Also inevitably, I’ll run into a huge spectrum of ETF-focused advisors, from the seasoned ETF expert to the absolute ETF novice. My hope is that they all self-identify correctly.

ETF Paradox
ETFs are a paradox. On the one hand, they take something that can be complex—like building a large-cap stock portfolio one company at a time—and make it mindlessly simple. With one trade, you can make an investment in an entire asset class with massive diversification, low costs and low tax impact. In many ways, ETFs are actually even easier than mutual funds—at least you know what it means when you hit the “buy” button on your trade.

ETFs are thus one of the great simplifiers in financial history.

At the same time, ETFs have opened up the entire menagerie of global investable assets. With very few exceptions, almost every liquid—and even quasi-liquid—investment in the world can now be bought in an ETF package. In this issue, we’ve highlighted a few of the examples in an attempt to shed some light on these less obvious corners of the ETF map, and of course, I hope you found it useful.

But perhaps the most important learning ETF investors need to undertake is internal. More complex ETFs—whether they be derivatives based, or thematic, or simply in an asset class that might be new to you, like real estate or junk bonds—require first and foremost a bit of self-analysis. You may have a handle on your risk tolerance and objectives, but how honest are you about your expertise? Whether it’s smart beta or local-currency emerging markets bonds, new asset classes come with a learning curve. We can help investors learn how more exotic ETFs work, but ultimately the burden is on you to understand the dynamics of the underlying assets in which you’re investing.

Risk Isn't Always The Issue
Importantly, this isn’t always about risk. Sometimes when we talk about more complex strategies, investors shy away, not because they don’t want to learn more, but because they assume anything that’s not plain vanilla is “risky.” In fact, many of the more complex ETFs—say, a buy-write strategy that uses options—are designed from the ground up to help manage risk. Just a few years ago, currency hedging was a new idea to many investors, and many shied away because they didn’t want to “add risk” to their international investments.

This kind of wooly thinking is unfortunate, but understandable. With over 2,000 ETFs to choose from, the learning curve can be steep, and indeed, the most exotic ETFs can seem a bit like those fabled dragons drawn at the edge of the world on old sailors’ maps. Smart investors, however, will know both what they’re after and do the homework to learn the ins and outs of the new tools.

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