There’s a new trend emerging in the investing world and (mercifully) it doesn’t involve neon, pleather or crazy-print pants. We’re talking about exchange-traded funds – more commonly known as ETFs – which have become so popular with investors over the past few years that the number of Canadian ETFs has tripled since the spring of 2009.Let’s start saying that this trend isn’t all marketing and hype; ETFs have some great features and benefits. But as with any trend, it pays to be cautious. What works for one person may not be a good fit for another.Here we’ll take a look at ETFs from both sides. Are these trendy investments hot...or not? We’ll lay out the facts and let you decide for yourself (your advisor can help)...• Hot: Diversification ETFs provide exposure to what’s called a basket of securities. This just means they track an index, a commodity or a basket of assets, much like an index fund would. Unlike a stock, this limits an investor’s exposure to any one security, and therefore lowers the risk of devastating losses (at least in theory). The verdict: Protecting your portfolio from a major crash? Very appealing, indeed.• Not: Marketing Have you ever noticed that as soon as any kind of trend catches on, it suddenly becomes obnoxiously present at every turn? The same is increasingly true for ETFs. And just as retailers try to lure shoppers toward certain items stocking more of them, financial institutions continue to expand the selection of ETFs to entice new investors. The verdict: Many of the ETFs on the market are great products, but some of the more eccentric, niche products may be too speculative – and too risky - for most investors. • Hot: Transparency You shouldn’t be clueless about what’s in your portfolio, whether you’re holding individual stocks, mutual funds or ETFs. ETFs have an advantage over mutual funds in this regard because most ETFs disclose their holdings daily, while mutual funds tend to do so on a quarterly basis. You might think you don’t need to know how much of a single stock your portfolio holds if you’re invested in an index, but if something really catastrophic happens to a particular stock, you can bet you’ll want to know about it.The verdict: Anything that helps investors make smarter choices is definitely a good thing.• Not: Fees ETFs are often marketed as being less expensive than mutual funds. And they are...sometimes. As is often the case with investing fees, sorting out the cost of ETFs is quite complicated, because it varies widely between products and providers. What is clear is that fees can significantly reduce the profitability of an investment. There’s also little evidence that you get what you pay for in this department.The verdict: Some investing fees are a given, but high fees and low returns definitely aren’t. ETFs may be subject to both trading fees and management expenses: watch out for both.• Hot: Convenience The reason that investors go gaga for ETFs is that they offer the diversification of index mutual funds, but can still be traded like stocks. Investors can even sell them short or buy on margin. This provides more options and greater flexibility than with mutual funds, which can have lock-in periods, deferred sales charges and other conditions that make selling them more difficult.The verdict: For savvy investors, flexible, liquid investments can help make it easier to respond to – and capitalize on – major market changes.• Not: Convenience (yes, there are two sides...) Many of us like to think of investing as a game of stealth, skill and the ability to strike at juuust the right moment. The reality is much less thrilling: some of the best investors make their fortunes choosing carefully and waiting a very long time. In that sense, the ability to trade ETFs on a whim can be a real drawback for undisciplined investors. In fact, several studies have compared long-term investing to active trading; so far, slow-and-steady is still winning the race. The verdict: The ability to trade ETFs both quickly and easily could lead some investors to incur significant fees while trading away potential long-term gains.Hot or not? Like any investment, ETFs aren’t strictly good or bad. In fact, whether you benefit from them has more to do with how you use them than the products themselves. It’s a little like any trend - you’re free to jump on the bandwagon, but if you do, please make sure you’re able to pull it off!
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