Seven Simple Mistakes Made By Investors In ETFs And Exchange-Traded Products: How To Correct The Errant Practices

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The seven actions described within reflect practices, many quite common, I’ve seen made frequently by Financial Advisors and do-it-yourself investors that I consider major mistakes. In fact, I strongly advise most investors NEVER to take these actions. 

This research demonstrates that these misperceptions and poor practices are deleterious to investor wealth. The last two may be especially controversial.

COMMON PRACTICES TO AVOID

  1. NEVER assume something is ETF because it trades like an ETF and is referenced in the media as an ETF. There are nuances in the structures that can lead to unpleasant tax surprises, price behavior differing from prices of underlying assets, and exposure to counterparty credit risk. Examples of these types of products are GLD, SLV, USO, UNG, and CAPE. GLD and SLV are direct interests in grantor trusts and are taxed at the higher IRS rate for collectibles, not as capital gains. USO and UNG are shares of commodities pools and subject to contango and supply issues. CAPE is an exchange-traded note that has counterparty risk with Barclay’s Bank. It’s fine to allocate funds to exchange-traded commodities and notes but not before a thorough read so you understand the implications.
  2. NEVER purchase an ETF without accessing and reading its fact sheet and summary prospectus. At a minimum, know what the structure is of what you are buying, whether it is active, passive index, or algorithmic index management, and its stated objective. Deep dives are better.  For example, there are “value” ETFs that hold Google and Amazon.
  3. NEVER submit a market order to buy or sell an ETF.  Market orders to purchase shares will be executed at the most recent “ask” price which may be close to the last sale or may be much higher depending on the ETF and the market. One of the major benefits of ETFs over mutual funds is knowing how much you will pay for a share of your fund when you buy it so why pay more for the share than necessary? Also, market orders for ETFs during the flash crash resulted in huge and unexpected losses. 

Place a limit order less than or equal to the ‘bid” price. This is generally preferable for individual stocks as well. It avoids setting you up to be “picked off” at a higher buying price or a lower selling price by professional traders. Most ETFs have a ticker listed on the factsheet for the indicative Net Asset Value per share of the fund which can be used as a guide for limit order pricing on funds that exclusively contain US securities.   

  1. NEVER EVER use a stop-loss order to sell ETFs or anything else for that matter. This is an invitation for professional traders to take the ETF’s price down to your execution level. 
  2. NEVER think you are buying the US stock market by purchasing DIA, the ETF based upon the Dow Jones Industrial Average. The US market has more than 6000 stocks.  Its exposures cannot be captured by 30 stocks. There are many other problems with DIA as an investment as detailed in an earlier blog article.
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Disclosure: I hold positions in VTI and BAR

Disclaimer: Always read the fact sheets and/or summary prospectus before buying any ETF.  Past performance is not necessarily indicative of ...

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Flat Broke 1 month ago Member's comment

Great advice.