The 4 Biggest Myths About ETFs Analyzed

Why invest in one stock when you can invest in the entire sector

Have this commercial stuck in my head and decided to act upon it and do some deeper digging into ETFs. It seems to me that there isn't anything bad said about ETFs (it could just be my age group, as people in their 20 somethings have a bigger appetite for risk, generally). So I decided to look into what are totally not true about ETFs. Here's what I found:

• ETFs are most appropriate for institutional investors and day traders.
• ETFs are riskier than mutual funds.
• Actively managed ETFs generally have higher returns than passively managed ETFs.
• When stocks are extremely volatile, ETFs often fail to track their intrinsic value

Myth 1: Although the first ETF was designed in partnership with the American Stock Exchange, ETFs are for all investors and not just institutional investors.

That's led retail investors to flock to ETFs. A Deutsche Bank study found that at the end of 2015, individual investors held 41 percent of ETF assets and institutions owned 59 percent.

Myth 2: Both (ETFs and Mutual Funds) have a similar amount of investment risk. In terms of operational risk, liquidity, transparency and tax efficiency all favor to the side of the ETF.

ETFs are traded throughout the day and priced in real time, while mutual funds are priced once daily at the market close. ETFs disclose their holdings daily, while most mutual funds only disclose their holdings on a quarterly basis. Trading activity can generate additional transaction and tax costs for mutual fund shareholders, while the creation/redemption mechanism of ETFs can reduce these costs.

Myth 3: This isn't exactly a myth, as it depends on your time horizon. Although actively managed ETFs have become much more popular. There seems to be an increased focus on smart beta products in the market, providing a bridge between the active and passive market.

Myth 4: ETF pricing is dependent on real time market prices and liquidity of underlying securities.

When there are market-wide disruptions, equity or fixed income, ETFs may experience temporary deviations from their intrinsic value. However, in some cases,instrinic value itself may be compromised due to lack of real-time market data.That being said, ETFs trade continuously on exchange and, in some cases, can provide price discovery for an asset class.