Is putting all your money into ETFs a good idea?

Question

If I am a trader, I'm looking to be focused on trading. This likely means my investments will be diversified into the ETFs that model the indexes. So my question is: besides general index and market risks, are there any additional risks to ETFs? These may include, but are not limited to:

ETF failure/going out of business - I don't know if this works or is even possible. Is it a concern?

Other deviations from the indexes

Please note: for the purposes of the question only, I'm not talking about bonds or foreign market exposure, currency hedging, etc. Although I will likely use those practices in my retirement portfolio, this question is concerned exclusively about the ETFs

Thanks for your help! Educated and experienced investors only, please. Thank you.

Answer 1

Well, if you are a high velocity trader (ala daytrader or something close), maybe not, but something like weekly or monthly or some such seasonal frequency (as in industry or sector flavor of the month), then yep, though I doubt you have that kind of patience.

As for safety, well, if you trade individual stocks now and are looking at ETFs underwritten by some major players (ishares, holdrs, etc.) then these are going to be safer than the individual issues. That is the primary value -- diversification. But, diversification is what dilutes its trading value. So if you are expecting to trade ETFs like steering a skeedoo water speeder, they move more like a big freighter or ocean liner. The value is reflective of the net asset value (NAV) of the stocks the ETF holds. This, then, is the relative slowness of ETFs.

ETFs are hardy and hard working burros, not fast accelerating, quick turning quarterhorses. Your money will last longer in an ETF, but it won't fly fast whether the issues are up or down. It is the nature of the beast.

BTW, ETFs can be shorted on the down-tick, which you can't do with common stocks.

Answer 2

Avoid going with indexes alone in this type of market. If you've got the time, spend it on selectin stocks - the better ones are generating very good returns without getting mired down with the weight of the market and/or sector

Answer 3

Compared to other Open-end (mutual funds) or Closed-end funds, ETFs are less risky, more liquid and the ones that trade the closest to their NAV. Contrarily to mutual funds, they are traded on the secondary market, which makes them more liquid. And contrarily to Closed-ended funds, they can be created in theoretically unlimited quantity. ETF's also allow for arbitrage which drives their price closer to their NAV.

ETFs are also less expensive and less risky because they are not actively managed and because they are fully backed by underlying assets/stocks (no leverage unless being part of the raison d'etre of the ETF).

Besides the two risks you mentioned, I don't really see other risks (other than risks related to the sector or industry the fund is invested in, interest rates, prices) or other 'obvious' risks, such as non-diversification and specialization.

Normally, ETFs are stand-alone funds which do not require investments/leverage from the part of issuing bank. So, normally, even if the bank fails, the fund should survive as an independent entity. And even if it doesn't, you can easily redeem your ETFs against real stocks.

This is just my own opinion: Having said that, however, in the extreme case mentioned above, small investors may not be able to redeem their ETFs as quickly as big investors (since redemption is done only in creation unit which are sometimes thousands shares). Small investors may be able to exchange their ETFs later once the Fund is liquidated, but I am thinking about the huge impact the selloff of underlying stocks will have on price (once redemption is completed by big investors) that once small investors are able to get their stocks, they will be overly 'underwater'. (just in case, the redemption of an ETF by an investor means that the investor sell back the ETF to the issuing bank in exchange of underlying stocks. Once investors get possession of stocks, they would most probably sell them, as many are not really interested in holding thousands of dozens individual stocks, that would depress prices, probably squeeze many arbitrageurs, and (i'm not sure about this) in case the issuing bank is using ETF underlying or 'collateral' stocks to lend them to margin buyers or short sellers, it may have inimaginable consequences)

To get back to your first question, no matter how good ETF are, you absolutely should not put all your money on them (no one asset class or strategy is good enough for that). ETFs are indexed, and like all indexes are surely less risky but also low rewarding. Try to use them as part of strategies like hedging for example: long few positive alpha stocks and short the ETF and vice versa (they helped me a lot for example because I was long AAPL and couple other tech stocks and short XLK and I was short few big banks and long XLF) or to time the market.

Answer 4

Companies like Barclay's (iShares), Vanguard, State Street Bank, Merrill Lynch etc run the big ETF's. Their structure is highly regulated & in fact represent 2/3rds of the activity on the American stock Exchange.  This stuff is big!

Even if these companies go oput of business.... the structure of the ETF puts it outside of the liabilities nd touch of their managers.

ETF's with the right "asset allocation" can work great for the position investor. I also swing trade and use ETF's regularly.

I even use ETF's for Option strategies like, covered calls, verticals, Iron Condors, Calenders etc.  

I read Barron's every week, Stocks and Commodities Magazine, SFO, Trader and several other periodicals. I have never seen an article about a "danger" of an ETF.

Good luck.

Answer 5

If you want investments for your IRA accounts...and you are " familiar" with investing...why would you choose ETFs? Don't you think the total exposure to a given sector just reduces your chances of nice returns?  I would rather trust IRA money to mutual fund managers in a sector fund... picking and choosing the best and selling off the losers...

If you are trading outside your IRAs , play with anything you want, but in your IRA, get a good intn'l fund, an energy fund, materials fund , maybe a chem fund for awhile... hold those for two, three, or four years and compare them to your other accounts in ETFs. If you are " trading" in ETFs and index funds...those sector mutual funds will be way ahead of you.

(...and that's a good thing...if there is someplace you want improved returns, it's in the IRA ...roll up a nice balance and get cautious when you have profits to " protect" )