The Achilles Heal of ETFs in Your Portfolio

Exchange Traded Funds (ETFs) came on the scene in the 1990s and have since gained tremendous popularity. ETFS provide a way to gain access to passive indexed funds for individual investors. They’re kind of like the cousin to mutual funds, which many people are more familiar with. Unlike mutual funds, they are not actively managed, resulting in significantly lower fees. During a bull market, this can make ETFs seem like the clear winner over mutual funds.

 

But what about during a bear market? Or times of market uncertainty? Uncertainty is the exact situation we’re in right now.

 

Passive management can also be a draw back.  You are tied to an index, and at the mercy of the index’s movement. This means a manager of the fund will not take into consideration current market conditions and will not make defensive moves. This can be a problem.

 

Take, for instance, the fund SPY. This fund is designed to track the S&P 500. Over the past month, that has not been such a bad thing. But, what if the tide changes? It may be more advantageous right now to invest in a portfolio containing some bonds or defensive stocks like utilities should the tide change.

 

Another problem is concentration risk. Everyone knows the name of the investment game is diversification. The S&P 500 is NOT reflective of the performance of the top 500 U.S. companies as one might think. In fact, as of today, 22.55% of the S&P 500 is comprised of just 5 companies (Microsoft, Apple, Amazon, Facebook, and Google). As you can see from that list, not only would you have 22.55% of every dollar you are investing backed by the performance of just 5 companies should you purchase an S&P 500 ETF, you’d also be mostly concentrated in the tech sector. This is exposing you to concentration risk you may not be aware of, and often should avoid.

 

What about the other 455 S&P 500 companies? According to an article on MarketWatch, over the past month, the casino sector is down 18%, department stores 19%, hotels, resorts and cruise lines 25%, and airlines 28%. This is an entirely different story than that of what the S&P 500 index is telling.

 

What does all this mean? I already mentioned diversification is extremely important. I’ll double down on that. ETFs have their place. But so do mutual funds. It is a good idea to carry both in your investment portfolio. This will help curtail fees, but also allow for broader diversification and strategic movement when the times warrant it. Please note diversification does not assure or guarantee better performance and cannot eliminate the risk of investment losses. An investment cannot be made directly into an index.

 

Give Campbell Financial Services a call to discuss your investment goals, risk profile, and investment allocations. We’ll make sure you are on track and continually making smart financial decisions.