These investments started with the noblest of intentions... But today, they're not always your friends.
Exchange-traded funds ("ETFs") grew out of the classic index fund. That's a financial instrument John Bogle invented in the 1970s. Index funds offered investors fractional shares of the entire market, without charging high fees.
Because they cost much less than the typical mutual fund, index funds made it easier for retail investors to build wealth. The idea caught on... And soon, index funds evolved.
They became ETFs. These funds traded continuously and were exposed to an options market. Folks could even borrow cash to buy them on margin. They became tools for speculation, much like stocks.
Established ETFs can still be a great way to invest. But over time, ETF companies have started chasing trends in the hopes of earning more management fees... And last month, that led to a truly preposterous move.
Let me explain...
If you're an investor, you probably own some ETFs. These funds bundle big baskets of stocks under a single ticker symbol. Investors can buy the basket for only a small management fee.
The stocks in each fund always share a theme. For example, the Real Estate Select Sector SPDR Fund (XLRE) lets you own companies in the real estate sector. And the VanEck Agribusiness Fund (MOO) gives you broad exposure to farming stocks.
But these funds aren't always in investors' best interests.
The problem is timing. A lot of new ETFs launch right when an investment theme is heating up... because they want to ride the wave of investment dollars. Unfortunately, that's usually when the biggest gains are already over.
My colleague Brett Eversole has written about this problem before in DailyWealth. He used two homebuilding ETFs as examples: the iShares U.S. Home Construction Fund (ITB) and the SPDR S&P Homebuilders Fund (XHB). Here's what he said...
These two competing funds track the homebuilders sector. And they came to market near the peak of the housing boom... at a time when everyone wanted to bet on a spectacular bubble in home prices.
The problem was, the bubble was about to burst. XHB fell more than 80% in its first three years of existence. ITB fared even worse... It dropped nearly 90%.
Launching a homebuilders fund in 2006 was a terrible idea for investors. Anyone who bought at launch lost most of their capital in the years that followed. But iShares and SPDR didn't launch those funds because it would be great for investors. They did it because it was a great idea for them...
Last month, an ETF debuted with arguably worse timing than ITB and XHB in 2006. I'm talking about the Roundhill BIG Bank Fund (BIGB)...
This fund provides exposure to the six largest money-center banks in the U.S. And it started trading on March 21... days after the conclusion of a full-blown banking crisis.
Roundhill believed the crisis had sparked a trend toward safety in banking. It expected a rush into banks that were "too big to fail." And in a press release, the company said the new fund would let folks invest in those larger institutions, without exposure to suffering regional banks.
At the time BIGB launched, customer deposits – the lifeblood of any bank – were in freefall. Take a look...
In reality, the March bank run caused a flight away from banks and financial institutions across the board. And it's unclear how long it will take that trend to reverse.
Nevertheless, BIGB offers you a way to own six giants in this bleeding sector... all for a pricey management fee of 0.29%. For comparison, the SPDR S&P 500 Fund (SPY), an ETF that tracks the overall market, charges a management fee of just 0.09%.
BIGB is up almost 3% since its inception. But this fund is making a risky gamble on investor sentiment. If more headwinds appear in banking, it could fall hard.
But Roundhill, the company behind the fund, likely isn't thinking about this. Instead, this looks like what a lot of ETF companies have done in recent decades... a move to cash in on trends, buzzwords, and hot topics.
That might be in these companies' best interests... But it's a shaky approach to growing your wealth.
Before you buy BIGB or any other new ETF, remember to do your research. Learn the fund's investing thesis, and shop around to compare other funds' management fees.
ETF companies have a big incentive to sell you funds you may not want to own... But with due diligence, you can avoid getting burned by their poor timing.
Sean Michael Cummings
It might not be exciting – but as an investor, it's important to do your research. A few basic steps can help you invest in solid companies with less risk... Read more here: Make Safer Investments With These Four Rules of Thumb.
From speculations to "Steady Eddie" businesses, even great investment ideas can backfire if you don't take steps to minimize your losses. Before you buy an exciting stock, make sure you know how to protect yourself... Learn more here: How One Trader's 'Safe' Bet Turned Into a $380,000 Loss.
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