5 Risks ETF Investors Take That Advisors Can Correct

As doctors have a duty to their patients, so too do financial advisors have obligations to their clients.

Doctors promise to follow the Hippocratic Oath, which is generally repeated today as “first, do no harm.” (The oath doesn't include that specific phrase.) 

The idea is that doctors must take an ethical approach to fixing what ails their patients without making things worse or putting their own priorities ahead of the patient.  

Registered Investment Advisors (RIAs) have a fiduciary obligation to their clients, essentially their version of the Hippocratic Oath. However, when advisors explain to clients that they are fiduciaries, and pledge to always work in their clients’ best interests, there is a hole in the process. It does not explicitly require them to protect clients from themselves.

And, while advisors aim to do that, they can’t have their head on a proverbial swivel. That’s where ETFs can help advisors confront and correct faulty beliefs that clients might cling to. Anyone can learn how to invest, but that doesn’t mean they learn to separate myth from reality.

Combating Weapons of Mass Wealth Destruction

So, advisors can go above and beyond the basic fiduciary standard by understanding and communicating several common investor beliefs that, while they sound fine, and are backed up by constant hype, they have been among the biggest wealth destroyers in past market cycles. Here they are, along with how advisors can use ETFs to help clients correct their course and avoid common temptations that may be stealth risks to their portfolios.

• Relying too much on past performance 

We get it. It feels good to buy something that has performed well. But if a client has their heart set on buying an ETF because they “missed out,” the only thing that past performance guarantees is that they can't have that past return! This was a feature (or a bug) of the dot-com bubble era.

In the three years before March, 2000, the SPDR S&P 500 ETF Trust (SPY) rocketed higher by 111%, an annualized gain of nearly 30%. Fear of missing out overcame many investors, but those whose advisors learned long ago that the past is not prologue were able to moderate those emotions and plan accordingly.

Many advisors rescued clients from the worst of SPY’s 41% decline over the next three years, through March 2003. That produced a total return across that full six-year period of 22%, or about 3% annualized, trailing many money market funds over that time frame.

• Thinking they're diversified when they aren’t 

Investment advisors recognize that while the S&P 500 has dominated performance charts and captured hearts, much of that performance has overlap with the top-heavy Nasdaq 100. By showing clients how SPY and even global equity ETFs like iShares MSCI ACWI ETF (ACWI) are highly influenced by the performance of ETFs like the Invesco QQQ Trust (QQQ), they can prevent clients from developing a “collection of investments” when a well-constructed portfolio of truly diversified ETFs would be better. 

• Focusing too much on expense ratios 

Expense ratios are important, but very often investors overstate their significance. Net return is the name of the ETF game, and especially when advisors look underneath the broad market indexes for ideas, they find they get what they pay for.

• Confusing ETF asset size with liquidity 

ETFs are only as liquid as the underlying assets they aim to buy. For example, smaller ETFs that invest in large cap stocks can go hours or days without trading, and still be bought and sold without significant price slippage. Advisors and investors can use the etf.com tradability features that are shown for all ETF profile pages.

• Limiting the use of ETFs to long-term investing 

Advisors don’t have to be hedge fund managers to use ETFs to rotate among asset classes, sectors, industries, or themes. Investors who determine that owning, for example, just SPY as their equity portfolio, probably don't have an advisor anyway. Thus, ETFs allow advisors to be active managers, while using ETFs as the primary allocation and rotation tool, rather than restricting themselves to stocks, or mutual funds that only trade at daily closing prices. 

Advisors are their clients’ financial physicians. They don’t have the same oath, but there are many ways they can super-charge their fiduciary role to clients by preventing accidents before they happen.