Hey everyone, welcome back.
Today we're diving into the world of ETFs.
Exchange traded funds.
Yeah, exactly.
Yeah.
Those baskets of assets you can trade like stocks.
Super popular these days.
Absolutely.
Convenience, diversification, loafies, what's not to like.
Right?
Sounds like a dream.
But we came across this podcast.
It's called The Shocking Truth About ETFs,
What They Don't Want You To Know.
Woo, catchy title.
Yeah, a bit dramatic maybe.
But it got us thinking, you know.
Are ETFs really all they're cracked up to be?
So we thought, let's do a deep dive.
And pack some of the less glamorous aspects,
the stuff they don't always tell you
in those shiny brochures.
Exactly.
Now look, we're not saying everything in that podcast
is gospel, but it definitely raises some interesting
questions.
And we want to explore those questions with you.
More like analyze them, right?
Think critically, separate the hype from the reality.
Exactly.
So let's start with this ETF boom everyone's talking about.
I mean, over $10 trillion globally invested in ETFs.
That's huge.
It's a testament to their popularity, no doubt.
Easy to use, accessible to a wide range of investors.
Right.
But one of the things that really struck me in that shocking truth
podcast was this anecdote about space exploration ETFs.
Oh, I remember that one.
So apparently a lot of the companies in this ETF
weren't actually building rockets or planning missions
to Mars.
They were just satellite providers.
Not quite the image that comes to mind when
you hear space exploration, is it?
Right.
It's like I'm picturing astronauts and moon landings,
and then it turns out I'm invested in companies
that beam cable TV signals from space.
It's a great example of how marketing can sometimes
create a disconnect from the underlying reality.
Investors get drawn in by the theme, the story.
But they don't always look closely
at what's actually in the ETF.
It's a reminder to always do your homework,
read the fine print.
OK.
So lesson one, don't judge an ETF by its cover, right?
Right.
Now let's talk about liquidity.
Yes.
The ability to buy or sell an asset easily
without causing big price swings,
it's crucial for any investment.
And we often hear that ETFs are super liquid, right?
It's one of their big selling points.
But is that always true?
The shocking truth podcast made me question that assumption.
Yeah.
They highlighted the fact that an ETF's liquidity is actually
tied to the liquidity of its underlying assets.
So if an ETF holds a bunch of illiquid assets,
like certain types of bonds, things
can get tricky if a lot of investors want to sell quickly.
Exactly.
You can't just assume that because it's an ETF,
it's automatically easy to trade.
Right.
And they gave a specific example.
It was the iShares iBox dollar high yield corporate bond
EPF ticker HEYG.
I'm familiar with that one.
A popular choice for investors seeking higher yields.
But during the market crash in March 2020,
this ETF traded at a significant discount
to its net asset value.
Wow, that's a big red flag.
What happened?
Well, the underlying bonds, those high yield corporate bonds,
became very difficult to sell in a panic.
So the ETF itself was liquid, meaning
there were plenty of buyers and sellers for the ETF shares.
But the underlying assets were not.
Exactly.
And that disconnect, that mismatch,
can lead to unexpected losses for ETF investors.
It's a reminder that even in the world of ETFs, which are often
seen as more transparent and efficient
than traditional mutual funds, you still
need to understand the underlying assets.
OK, so we need to be mindful of what's inside the ETF,
not just the name or the category.
And then there's this whole other world of synthetic ETFs.
Ah, yes.
Those are interesting creatures.
To be honest, I didn't really grasp the concept
until I listened to that podcast.
Well, they can be a bit complex.
Instead of directly owning the underlying assets,
synthetic ETFs use derivatives, specifically swaps
to track an index.
OK, I'm already lost.
Derivatives, swaps.
Think of it like this.
You want to battle on the performance of the S&P 500,
but you don't want to buy all 500 stocks individually.
Yeah, that would be a lot of paperwork.
So you enter into a swap agreement
with another institution, usually a big bank.
The bank promises to pay you the return of the S&P 500.
And in exchange.
You pay them a fee.
It's like you're outsourcing the actual ownership
of the assets.
OK, that makes sense.
But doesn't that introduce extra risk?
I mean, what if the bank goes belly up?
You're absolutely right.
That's where counterparty risk comes in.
It's the risk that the institution
on the other side of that swap might not
be able to fulfill its obligations.
So it's like a chain if one link breaks,
the whole thing falls apart.
Exactly.
And with synthetic ETFs, you have that extra layer
of counterparty risk that you wouldn't
have with a traditional ETF that directly owns the assets.
OK, so another thing to be aware of.
Now, let's talk about diversification.
It's like the golden rule of investing, right?
Don't put all your eggs in one basket.
Absolutely.
Diversification is crucial for managing risk.
But the Shocking Truth podcast actually
challenged that notion, saying that over-diversification
can be a problem.
Hm, that's an interesting perspective.
It's true that more isn't always better.
At some point, you might start to dilute your returns.
They use the S&P 500 ETF as an example.
It's very popular.
It tracks a broad market index.
But maybe we don't actually need to be invested
in all 500 companies.
That's a good point.
Let's say your goal is long-term growth.
You're comfortable with a moderate level of risk.
Owning an S&P 500 ETF might seem like a safe bet,
but you're essentially exposed to the entire US large cap
market.
Right, which might not be the most efficient way
to achieve my specific goals.
Exactly.
And that brings us to the concept of strategic diversification.
OK, so it's not just about owning a lot of different things.
It's about choosing investments that complement each other
and actually align with your goals and your risk tolerance.
Exactly.
You need a plan, a strategy.
Don't just diversify for the sake of diversification.
That makes a lot of sense.
Now, another thing that the podcast got me thinking about
is the ETF industry itself.
I mean, it's a business, right?
Yeah.
And like any business, it's driven by profit.
That's a crucial point that often gets overlooked.
We tend to think of ETFs as these passive low-cost
investments, but there are big companies behind them,
and they're in the business of making money.
Right.
They mentioned BlackRock and Vanguard,
these giants of the financial world.
They create and market ETFs, and they make money through fees.
And those fees, even if they seem small,
can eat into your returns over time,
especially if an ETF doesn't perform well.
So we can't ignore the fees completely,
and then there's this whole trend of thematic ETFs,
which I find fascinating.
Those funds that focus on specific themes like green energy,
artificial intelligence, or even as we saw earlier,
space exploration.
Thematic ETFs can be very appealing,
especially to newer investors who are excited
about a particular trend or industry.
Right.
It's like, I believe in the future of clean energy,
so I'm going to invest in the clean energy ETF.
But as we learned from that space exploration example,
we need to be careful.
Absolutely.
A catchy name and a compelling story
don't guarantee success.
You need to look beyond the marketing
and see if the underlying holdings actually match the theme.
And if they have the potential to generate the returns
you're hoping for.
Exactly.
Don't let excitement cloud your judgment.
Always do your research.
OK.
So we've talked about marketing hype, liquidity concerns,
counterparty risk, over diversification,
and the profit-driven nature of the industry.
Is there anything else we need to be aware of?
Well, the podcast also raised a concern
about systemic risk, which is something that's
been on my mind a lot lately.
Systemic risk.
What's that?
It's the risk that a problem in one part of the financial system
could trigger a cascade of failures leading
to a broader market meltdown.
OK.
That sounds scary.
It is.
And the concern with ETFs is that if everyone piles
into the same popular ETFs, it could actually
create instability in the market.
So it's like if everyone tries to exit a crowded theater
through the same door all at once.
Precisely.
If a large number of investors suddenly
want to sell their ETF shares and there aren't enough buyers,
prices could plummet.
And that could create a ripple effect
throughout the market, exacerbating a downturn.
OK.
That's a sobering thought.
So it seems like there's a lot to consider when it comes to ETFs.
It's not just about picking a catchy name
and hoping for the best.
Absolutely not.
ETFs can be powerful tools for building
a diversified portfolio.
But like any tool, they need to be used wisely
and with a clear understanding of the risks involved.
We need to be informed investors doing our due diligence
and asking the right questions.
So for everyone listening, let's take a moment
to absorb all this information.
And then we'll come back with some practical tips on how
to choose and use ETFs effectively.
Stay with us.
We'll be right back.
Welcome back, everyone.
Hope you all had a good chance to let all that sink in about ETFs.
Now let's talk strategy.
Yeah, let's get practical.
What can we actually do with all this information?
Right.
We don't want anyone walking away thinking ETFs are a bad idea.
No, definitely not.
They can be great tools, but we need to use them wisely.
Exactly.
And that starts with, you guessed it, research.
Always research.
I feel like that's our motto on this show.
Well, it's good advice for any investment, but especially ETFs.
It's tempting to jump on the bandwagon,
you know, see a hot new ETF.
Everyone's talking about it.
Oh, yeah, the FOMO is real.
But before you hit that buy button, take a step back.
Read the ETF's prospectus.
The prospectus.
Ugh, that sounds so boring.
I know.
It's not exactly a page-turner.
But it's packed with information.
You wouldn't buy a house without inspecting it, right?
True.
So the prospectus is like the home inspection report
for an ETF.
Exactly.
It tells you everything you need to know about the ETF's holdings,
its investment strategy, its fee structure.
OK, so where do we even start?
Yeah.
What should we be looking for in that mountain of text?
Two key things I always focus on are liquidity and tracking
error.
Liquidity we talked about earlier, right?
Making sure you can easily buy or sell the ETF
without huge price swings.
Exactly.
The prospectus will usually have data on the ETF's average
daily trading volume, which can give you
a sense of its liquidity.
And tracking error.
Remind me what that is again.
Sure.
It measures how closely the ETF's performance matches
the index it's supposed to track.
You want a low tracking error, which
means the ETF is doing a good job of replicating
the index's returns.
So it's like a report card for the ETF.
Is it doing what it's supposed to do?
Exactly.
OK, so we've done a research.
We've found some ETFs that seem to fit the bill.
Now what?
How do we actually use them strategically?
That's where the fun begins.
ETFs are so versatile, you can use them
for all sorts of investment goals.
Like what?
Give me some examples.
Well, let's say you're looking for stability and income.
Bond ETFs can be a great option.
Right.
Bonds are generally less volatile than stocks.
They can add some balance to a portfolio.
Exactly.
And there are so many different bond ETFs to choose from.
You can focus on different types of bonds, different
maturities, different credit qualities.
So you can really customize it to your needs.
Exactly.
Now what about inflation?
That's a big concern for a lot of investors these days.
Yeah.
Prices are going up everywhere.
It's definitely on my mind.
What can we do about that?
Well, one way to potentially hedge against inflation
is to invest in commodities.
Commodities, like oil and gold.
Exactly.
Things like gold, oil, agricultural products,
their prices tend to rise when inflation is high.
OK, that makes sense.
And I'm guessing there are ETFs for that.
You bet.
There are broad commodity ETFs that
track a basket of different commodities.
And there are also sector-specific commodity ETFs,
like a gold ETF or an oil ETF.
So you can really target your exposure.
Exactly.
Now it's important to remember that commodities
can be volatile, so they're not for everyone.
Right.
But if you're looking for an inflation hedge
and you're comfortable with a bit more risk,
they could be worth considering.
Exactly.
And then another way to use ETF strategically
is to gain exposure to specific sectors of the economy.
Let's say you're bullish on the renewable energy sector.
OK, yeah, that's a hot topic these days.
So you could invest in a clean energy ETF.
It holds a portfolio of companies
involved in solar, wind, other forms of renewable energy.
So instead of trying to pick individual stocks,
I could just buy an ETF that covers the whole sector.
Exactly.
It's a convenient way to diversify
within a particular sector.
And speaking of sectors, remember that Shocking Truth
podcast episode we talked about earlier?
The one with the space exploration ETF.
Yeah, they actually brought up energy ETFs and oil price
fluctuations, which is a good example of how
sector-specific ETFs can be affected by market forces.
Oh, yeah, I remember that.
So if oil prices go up, energy ETFs tend to do well.
Exactly.
But if oil prices crash, those ETFs are going to take a hit.
It's a reminder that even though ETFs offer diversification,
they're still subject to the same risks
as the underlying assets.
So it all comes back to understanding
what's inside the ETF.
Absolutely.
And that's why research is so important.
You need to know what you're buying and why you're buying it.
OK, this is all making sense now.
But it seems like a lot of responsibilities
on the investor to do all this research
and make informed decisions.
What about people who don't have the time or the expertise
to dig into all these details?
That's a great question.
And it's something I hear all the time.
Not everyone wants to become a financial expert.
Right.
Some people just want to invest their money
and get on with their lives.
Exactly.
And that's where a financial advisor can be really helpful.
They can help you assess your financial situation,
your goals, your risk tolerance, and then
recommend investments that are appropriate for you.
So it's like having a coach in your corner guiding you
through the process.
Exactly.
And a good financial advisor can also
help you navigate the complexities of ETFs,
make sure you're making informed decisions.
That makes a lot of sense.
So research professional advice, it all sounds very sensible.
But I'm sure our listeners are eager for some more specific
tips on choosing the right ETFs.
What do you say we dive into some actionable strategies?
Sounds like a plan.
Let's get into it.
All right.
So we've talked about a lot.
We dove into some of the potential downsides of ETFs,
talked about some of the benefits,
even touched on getting some professional help,
which is always a good idea.
But now I'd like to just summarize everything.
What are the key takeaways our listeners should remember?
Sure.
Let's make it actionable.
Most importantly, remember, ETFs are tools, not some magic
bullet.
They can be really useful for building a diversified portfolio,
but the market still matters.
And so does really understanding what's inside each ETF.
Yeah, that's story about the space exploration ETF.
Really stuck with me.
Yeah.
It's a good reminder that marketing can be, well,
very persuasive.
We need to be sure to look beyond the hype
and understand what we're actually buying.
Exactly.
Don't let those flashy names fool you.
Do your research.
Read that prospectus, even if it's boring.
I know.
Those prospectuses can be dry, but they're
full of important information.
The ETFs investment strategy, the holdings, fee structure,
potential risks, it's all in there.
So it's like our homework before we invest.
And another thing that struck me was
that more diversification isn't always better.
Right.
Strategic diversification is what we should aim for.
Think about your goals, your risk tolerance.
Each ETF should have a purpose in your portfolio.
Don't just buy a bunch randomly.
Have a plan.
Yeah.
Don't just check the diversification box
and think you're done.
Exactly.
And another thing, those fees, ETFs are often
marketed as low cost, which is great,
but we still need to be mindful.
Yeah.
Those little percentages can add up over time,
especially if the ETF isn't doing well.
Exactly.
Do some comparison shopping.
A slightly higher expense ratio might be justified sometimes
if the ETF has a good track record,
a well-regarded manager, a solid strategy.
And we also talked about systemic risk.
That was a new one for me.
The idea that ETFs could actually
contribute to market instability.
It's something to keep in mind, especially
as more and more money flows into ETFs.
It's like everyone trying to leave a concert at the same time.
Right.
It could get messy if everyone panics
and tries to sell all at once.
Exactly.
Diversifying your portfolio, different asset classes,
strategies, even different ETF providers can help with that.
Spread the risk around.
Don't put all your eggs in one basket, as they say.
Exactly.
So the main takeaway here, be informed.
Do your research and make conscious choices
about your investments.
Knowledge is power.
It's so true in investing.
We need to understand what we're buying and why.
Right.
It's not just about charts and numbers.
It's about your financial well-being, your dreams,
your future.
This has been a great conversation.
I feel like I have a whole new perspective on ETFs.
They're still a valuable tool.
But now I'm approaching them with, I don't know,
more awareness, I guess.
I think that's great.
And remember, learning is a journey.
The market is always changing.
New products pop up.
New strategies.
It's important to stay informed.
Always keep learning.
Absolutely.
So to everyone listening, keep exploring.
Don't be afraid to ask questions.
Investing doesn't have to be scary.
With the right knowledge and a bit of effort,
you can take control of your finances
and build the future you want.
Well said.
Great advice to wrap up on.
We covered a lot today, folks.
Remember, ETFs are powerful tools,
but they need to be used wisely.
Do your research.
Be aware of the risks.
Make informed decisions.
And until next time, happy investing, everyone.
That's it for this deep dive on ETFs.
Thanks for listening.