Reasons For Not Investing in ETFs

8/2/17

In the investing advice world, one often reads something like "just invest in an ETF that replicates the S&P 500, and you'll do OK." This view, I believe, is very flawed.

First, please show me just one person on the Forbes most wealthy list who got there from "buying and holding and adding to an S&P tracking ETF". I don't believe that will ever happen, and I think there is a reason for that. You will find a lot of average investors with average results and a lot of evidence that ETFs are popular. Those findings should make you pause and think.

Keep in mind that when you buy shares of an S&P tracking ETF you're not buying the actual shares of the companies comprising the S&P 500, you're buying units of a single stock (ETF). It is possible that something happens to, say, SPY itself, since it is, after all, just a single stock ran by a company. I don't think it very probable, but technically it is possible. Note that, like single stocks, many ETFs have also failed in the past for various reasons.

I actually happen to be an index fan (DIA, because of monthly dividends and it correlates well with the S&P too) but I think relying on them exclusively is what I call "pseudo-diversification" or "diversifiction" or "diworseification". In my opinion, it is almost always better to buy individual stocks and create your own index (especially if you do not get charged commissions) if you want to go that route. Heck, there are several stocks that are already index-like as is (BRK and GE come to mind). Companies making money from ETF fees will try and convince you that buying single stocks is futile "stock picking" with all the bad connotations but leave out all the benefits.

For example, adopting a buying individual stocks strategy will probably enable you to take more advantage of dividend growth, cutting losses earlier, control dividend payment frequency, keep any losses contained to a sector, invest more often, and actually own actual shares of companies you care about (not shares of an ETF) and want to have some voting power with. One could also buy an index-like ETF as the core and also select individual stocks for their portfolio.

Of course, most investors not completely indoctrinated in investing in index replicating ETFs eventually ask themselves "I wonder which of the several S&P 500 ETFs performs best?" and then notice that there are other indexes and weightings that perform even better. From there I find they are quick to notice simply that many individual stocks perform better.

Another issue that really bugs me is that the whole ETF investing paradigm makes people think of bond ETFs as actual bonds. This is just wrong, wrong, wrong. If you want to invest in Treasuries and are not buying plain-vanilla Treasuries from TreasuryDirect.gov, then you are not buying actual Treasuries, but stocks, and are simply increasing your costs and risks.

Last, investing in an ETF comprised of largest or the top 500, etc., companies, forces the investor to invest in companies that might be engaging in activities that go against their morals/ethics.

Thanks for reading!