John Bogle hates exchange-traded funds (ETFs), and he makes no bones about it — for example, read what he says in the November cover story of Research Magazine.
As the founder of the Vanguard Group and an index investing pioneer, he remains an influential voice and champion of the individual investor. But are his criticisms of ETFs accurate?
Let’s analyze three arguments.
1) ETFs Encourage Day Trading
Do ETFs induce investors to become day traders?
A recent Vanguard study, titled “ETFs: For the better or bettor?” debunked this popular claim.
The chart (below) shows a distribution of investments held for longer than one year sorted by the average annual rate of investment reversals. As illustrated, 99% of traditional mutual fund investments and 95% of ETF investments do not exceed a rate of four reversals per year. Moreover, less than 1% of Vanguard ETF positions averaged more than one investment reversal per month.
The report said, “Although behavior in ETFs is more active than behavior in traditional mutual funds, some of that difference is simply due to the fact that investors who are inclined to trade choose ETFs, not that investors who choose ETFs are induced to trade. We conclude that the ETF ‘temptation effect’ is not a significant reason for long-term individual investors to avoid using appropriate ETF investments as part of a diversified investment portfolio.”
2) ETF Costs are Rising
ETF critics correctly observe that the average expenses for ETFs are still low, but not as cheap as before. The average expense ratio for ETFs has increased to 0.56% in 2012 from 0.39% in 2005. But straight “averages” are deceptive.
By comparison, asset-weighted averages, where the largest ETFs carry more weight than smaller ones, render a more accurate picture of the actual costs ETF investors are paying. According to Vanguard’s research, the asset-weighted average expense ratio for ETFs is a substantially lower amount: 0.32% versus the simple average of 0.56%.
“We’ve found that when you take a closer look at the data, the averages are misleading because most of the money is flowing into lower-cost ETFs,” says Joel Dickson, a principal and senior investment strategist with Vanguard Investment Strategy Group. “It’s sort of the reverse of the Lake Wobegon effect.”