This is Why Exchange Traded Funds may be bad For You
Exchange Traded Funds (“ETFs”) are similar to mutual funds in that they offer great diversification and professional management. The fact that they are traded throughout the day also makes them liquid, low-cost and tax efficient.
Although this makes it seem like ETFs are the best thing that can happen to an investor, this is not always the case. In fact, ETFs are one of the riskiest investment products around. While they may offer great gain, they can also bring startling loss on top of the significant fees they may attract. The bottom line is: with ETFs, all is not always as it seems.
This of course puts investors in a difficult position. While professional, experienced investors should have no problem managing their ETF choices, the option can be disastrous for unsophisticated investors. The product has become more complicated in recent yearsa and often comes with increased risk for this class of investors.
The duty on financial advisors regarding investment products like this is to provide full advice to investors. If you believe you have not been properly advised on the risks and commitments required for ETFs, you may have a claim for liability against your broker.
Even the Securities and Exchange Commission advises serious consideration before selecting the product. It is the duty of your financial advisor to be certain that you understand the option and that it tallies with your investment goals and needs.
If you have been provided inaccurate, incomplete or misleading information about investment in ETFs, please contact us at Weltz Law. We can help you hold your financial advisor and their brokerage firm responsible for any loss you suffer as a result of the faulty advice.
Weltz Law has over 25 years experience before FINRA arbitration and the state and federal courts.
What are Exchange Traded Funds?
It is important to understand that ETFs are not mutual funds. Although they share many similarities with mutual funds, they operate in a much different fashion from mutual funds in practice.
ETFs are investment products that usually have holdings in a major stock index, such as Dow Jones. Often, they may have holdings in all or a significant number of companies in the index. Just like mutual funds, they are professionally managed and investors can buy shares in them.
However, unlike mutual funds, their shares are usually traded continuously throughout the day, similar to a closed fund. Their shares trade like stocks on an exchange and they can be bought or sold at fluctuating prices all through the trading day. Most ETFs are registered with the SEC under the Investment Company Act and their shares registered under the Securities Act. Others that invest in commodity futures are regulated by the Commodities Futures Trading Commission.
ETFs are meant to track the yield and return of major indexes such as Dow Jones or the S&P 500. Rather than seek to outperform these indexes though, what ETFs do is simply replicate the performance of the index. This means, simply, that if the index trades well by 5 points, ETFs will also generally increase by 5 points. And if the index loses 4 points, the same will occur with ETFs.
Another important thing to note about ETFs is their short term nature. They usually seek to achieve their objectives on a daily basis. This means it is best for investors that intend to sell short. If traded over a longer period of time, their performance can differ significantly from their mirror index.
ETFs are also passively managed, generally. Although, there are also actively managed ETFs that pursue investment strategies, rather than just seeking to replicate the index. ETFs have generally become so popular that they have seen massive growth, with up to $3.6 trillion in US assets.
Risks of Exchange Traded Funds
A lot of the risk in ETFs stems from the variations in the management style, investment objective or even indices tracked of various ETFs. These make each ETF distinctly different from others and can include increased risk and commitments.
- Narrow ETFs: These funds differ from general ETFs that track broad market indices. Instead, they track very narrow indices such as those made up of medium and small companies. Their indices may be even more narrow than that and may not be entirely transparent. One of the most basic rules of investing is diversification. This spreads risk and reduces volatility. With narrow ETFs comes much more increased risk as it becomes easier for all of your investment to suffer.
- Inverse ETFs: These funds attempt to do the opposite of the index they track. This means for instance, if the index drops by 6, the inverse ETF will rise by 6. Almost like trying to sell stocks short, this category of funds comes with great risk. As such, it requires sophisticated investment training and the experience to appreciate the dangers involved.
- Leveraged ETFs: Much like basic ETFs, this type of funds basically mirrors the performance of the index they track. However, leveraged attempt to multiply the performance of the index they track. This means, for instance, if the index rises by 2 points, a leveraged ETF will rise by 4. Of course, this is a very high stakes investment as the reverse will also be the case. This makes the investment very volatile and too risky for the average investor.
- Leveraged inverse ETFs: Just like leveraged ETFs, leveraged inverse ETFs attempt to multiply the performance of their tracked index. In this case however, they multiply this performance in the opposite direction. Making a good call here requires almost perfect judgment, as the risks of a bad call will be pretty bad.
At all relevant times, ETFs carry risks that the average investor will not ordinarily face in normal day trading. Due to this, it is important to understand ETFs very well before taking a decision to invest in them.
You should be able to understand the opportunity in simple terms and justify it in terms of your investment goals before making a decision. If you have invested without being advised properly, you may be able to claim compensation for your loss.
Broker Liability for Advice on Exchange Traded Funds
As an investor, your broker or financial advisor owes the duty to act in your best interests. At the heart of the duties you are owed by your broker is your right to be informed. You have the right to full and accurate information about the investment opportunities your broker advises you on. If they have failed to give you this information, you may be able to hold them liable.
Due to the fact that brokers and their firms stand to make a lot of money off ETFs, they have an interest in advising you to invest in them. But if they have put their interest before yours, and you lose your investment as a result, they may be responsible to you.
When they wrongly advise you in this regard, you may be able to file an unsuitability claim against them. FINRA rules 2111 and 2090 will apply in such instances. And if your broker intentionally misled you into purchasing ETF securities that are not appropriate for you, they may be liable in a fraud claim.