As detailed in Barron’s:
“ETF users are by no means a uniform group. We identify two distinct types: ETF investors and ETF traders.
Investors use ETFs as core building blocks in their portfolios mostly for asset allocation purposes. Meanwhile, traders use ETFs as liquidity tools mostly for non-asset allocation purposes.
ETF investors buy efficient access to asset class exposure; while ETF traders buy efficient access to asset class liquidity. Investors own the majority of ETF assets and represent a small fraction of ETF trading volumes; while traders own only a fraction of ETF assets, but represent the majority of ETF trading volumes.”
It’s amazing to see the relationship between ETF investors and traders here. While investors seek efficient allocations, traders seek liquidity. Both may dabble in the same ETFs from time to time, but investors hold all the assets while traders generate the volume.
There truly is an ETF flavor for every palate, from super low volatility to triple inverse leveraged. The key for investors is defining their identity and sticking with it, without being tempted to try and short gold or make a leveraged bet on oil’s recovery.
“Vanguard Group luminary Jack Bogle have long warned that too many people suffer from an identity crisis when using ETFs. His dart at ETFs, in a nutshell, is that ordinary folks can be tempted to speculate on niche strategies that are not really diverse. To Bogle, ETFs are gateway drugs into needless speculation.”
So while ETFs provide a beautifully simple way to diversify a portfolio with a single click, they also offer all the resources to erode an investor’s capital.
So be honest with yourself: Are you an ETF investor, or trader?
If you’re an investor, here’s a secret for you: a simple index fund like the Vanguard 500 Index Fund (NYSE:VOO) may be all you ever need to own.