'Ripoff' ETFs, Bogle's Fears: Hysteria or Real Worries?

It’s a dirty job, but someone's gotta do it. 

That’s what I chuckled to myself when I read a recent article from The Economist. The piece lamented the evolution of ETFs from straightforward index funds listed on the stock exchange, to what is in some cases, the equivalent of a “turducken:” a turkey with a duck inside and a chicken inside that.  

The analogy to ETFs is this: some are simply too complicated. While there may be some benefits to that complexity, the risk is that investors pay layers of fees, and don’t ultimately get what the ETF aims (or claims) to be able to do.

I’m no Wall Street apologist, and there are plenty of ETFs I find to be not useful or outright dangerous. But in the same way we can’t shame Coca-Cola or McDonald's for selling junk food and still talk about freedom to choose how we live our lives, we can’t shame ETFs that are created with the idea that there’s a need to be met.  

ETFs: Four Key Questions to Ask

The proof is not in the pudding in this case. It is in the assets under management, the lifeblood of any ETF’s ability to stick around long enough to validate the idea behind the issuer’s product. In other words, the ETF industry, like the consumer economy in general, comes down to this:

• What do people want?
• If someone creates that and tries to sell it to them, will they buy it?
• Is there an oversight entity responsible for protecting consumers (buyers of ETFs in this case) from misdeeds and deception?
• Is the buyer/investor in any ETF free to choose whether to buy it or not?  

I think the answer to all those questions is yes. It comes down to “buyer beware.” Frankly, if something smells too complicated, there are so many fish in the sea of the modern ETF marketplace, no one is forced to buy anything.  

Or, to use a phrase I borrowed from a fellow tenured professional investor, it may help to have three trays on one’s desk: in, out and too tough! There is nothing wrong with having the latter tray being the one that must be emptied most often, since it fills up so quickly. So too are ETF investors free to do their thing, whatever that thing is.

Buffered ETFs: Overpaying for Risk Management?

The Economist article expressed concerns about overpaying for risk-management, citing buffered and “defined outcome” ETFs. It also criticized semi-transparent ETFs and funds that are comprised primarily of private investments. I am but one voice in this industry, but I feel the same way about a lot of those newfangled vehicles. But the key to that sentence is this: “I am but one voice.” And one consumer. Different strokes for different folks, as they say.  

One key argument, which is far from unique to the article noted above, is that part of the “rip-off” is the concept that investors pay to limit downside risk, and the cost over the past many years has been a ton of upside they missed out on. That is fresh in my mind, since I literally wrote another article for etf.com the same day I’m writing this one, that covered how that is perhaps the most misunderstood aspect of investing!

ETFs Can Be a Key Risk-Management Tool

To summarize: investing is not about who makes the most money after we look back over some fixed time frame and judge. I call that “rear view mirror investing.” Last I checked, cheap term life insurance as well as health insurance are two of many things’ consumers use to pay for “not having to say you’re sorry you didn’t pay for it.” 

Maximum upside sounds nice until we recall that for about half this current century, from early 2000 through early 2013, the S&P 500 went up and down a lot, but ended up around where it started. Specifically, around the 1,500 level. So just because things have been blissful since, doesn’t erase the case for risk management. How does each investor choose to get that risk management? In whatever way they choose, subject to the alternatives available. That includes wide range of ETFs, which can be used individually or as a cohesive portfolio unit.  

“Buyer beware” for sure. Not only in the ETFs one chooses, but also in the bigger question of what they are trying to achieve by investing in the first place.