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The ABCs of ETFs: Are They Right For You?

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If nothing else, the last two years have taught us that it is important for every Woman Around Town to be financially astute. This column is the third in a three-part series on prudent financial management and further examines the investment vehicle Exchange Traded Funds, commonly referred to as ETFs. Part One of the series, The ABCs of ETFs: An Introduction and Part Two, The ABCs of ETFs: Building a Portfolio were featured here last week. Of course, everyone’s financial situation is different and before investing in any ETF, it is important that you consult your tax and investment advisor to see if these investments are right for you.

We hear a lot about transparency these days, always an issue in investing, but even more so given the subprime housing crisis that led to the credit crisis that then put us into the deepest recession we’ve experienced in our lifetime. Transparency in these derivative investments was nonexistent – banks and brokerage firms had no real idea of the underlying assets they were marketing, and we, the poor consumers, even less. So transparency is the current buzzword, and ETFs have it in spades. Because ETFs are traded on major stock exchanges, they must adhere to SEC guidelines. Each ETF must report its holdings. The derivatives that largely underlay the credit crisis were both undefined and unregulated.

There have been rumblings that ETFs suffered during the “flash crash” on May 6. Those who trade, rather than invest, may have been affected, as were those who panicked and tried to exit the market entirely. But for the long-term investor, seeking a lower cost, tax efficient, self-directed portfolio, ETFs make a lot of sense.

ETFs are not perfect – no investment is. In fact, there is evidence that fewer than 25% of investment managers outperform the market over the long term. Fees paid to investment managers add up, and they become a drain on portfolio returns when the manager underperforms. An ETF, and its lower costs, gives you the index return i.e., the S&P. No more, and no less. Not all investment managers can make that claim.

Investors can make mistakes too, and one of the biggest ones is setting a strategy and then reacting to market fluctuations by bailing out at the first sign of unrest. Successful investing requires patience.

Another error investors make is trying to “time” the market – guessing when the market is going to shoot up (or down) and then jumping in hoping to profit. This kind of knee-jerk strategy requires that you make 2 perfect decisions: knowing when to jump in and then knowing when to jump out. Believe the research statistics that suggest you can lose up to 80% of market returns by entering and exiting the market at the wrong times. That’s a big chunk of change to lose.

Again, the Ishares.com website has a plethora of information to begin learning about ETFs and the ways you can benefit. If that is not sufficient, a Google search on ETFs is guaranteed to give you even more. But don’t make the mistake of so many investors, giving in to something called analysis paralysis – where you spend your time looking at data while investing opportunities pass you by. Set an asset allocation, invest in the ETFs that support it, and give it time to work. That’s what investing is all about.

If you have comments and ideas about topics for future financial columns, please log in and let us know. We want all our WomenAroundTown to be fiscally fit!

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