Exchange traded funds (ETFs) are the hottest product since the mutual fund. Sure, other products like master limited partnerships, REITS and even a dramatic rise in options contracts join ETFs as the modern way to trade, but the ETF industry is $2.05 trillion large. It has products for everybody - from the newest of investors to the professional trader, and it doesn't have the high fees that come with some mutual funds.
But that's only part of the problem. When thinking about ETFs, "wolf in sheep's clothing" comes to mind for some. One of those is Jack Bogle. Don't know him? When Jack Bogle speaks, people listen, mostly because of two accomplishments that influenced the investing world in a big way.
First, he's the founder of the Vanguard Group. Established in 1975, the firm has 12,000 employees and over $2 trillion under management. Investors have long known the company for its low-cost, high performing family of products that includes mutual funds, ETFs and asset management services.
Second, Bogle is known as the father of the index fund. In 1976, he started the Vanguard 500 Index Fund, the first index fund for individual investors. It's still active today and has a low expense ratio of 0.17%.
Recently, Bogle made news when asked about ETFs. During an interview on Yahoo! Finance's Breakout, a web production that offers daily market commentary, he had cautionary words for those who put their money into ETFs, thinking that they're safer than other investments.
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Index Funds of Any Kind Are Fine
Bogle is a champion of the index fund and whether it's through an ETF or mutual fund, a passively managed index fund that tracks a broad market index like the S&P 500, Dow Jones Industrial Average or Russell 2000 is a good choice.
Some investors prefer ETFs, because they trade on the major exchanges just like stocks. Providing the fees are equally low, investors are well served by either of these types of index funds.
Sector and Country ETFs - Just Say No
Broad market ETFs that function just like index funds are appropriate for the retail investor, but what about funds with a more narrow focus? This includes sector funds, such as Financial Select Sector SPDR (ARCA:XLF), which tracks the performance of the financial sector of the market, or the Market Vectors Vietnam ETF (ARCA:VNM), which tracks the performance of companies based in Vietnam.
Bogle isn't a fan. The more focused the ETF, the more the investor is engaging in something that feels a lot like stock picking. Just as investors don't know where the market is going tomorrow or in a week, they don't know where a certain sector is going either.
SEE: Stock-Picking Strategies: Introduction
Bogle has made a career of telling investors that trying to beat the market is a loser's game and he doesn't think using an ETF is a better strategy.
"Fruitcakes, Nut Cases and Lunatic Fringe"
Leveraged ETFs are products that track a certain index but magnify its moves. The Direxion Daily S&P 500 Bull 3X Shares (ARCA:SPXL) moves three times more than the S&P 500. If the index moves up 1%, this ETF gains 3% (minus expenses). Sounds like a trader's dream until the S&P moves down 1%.
A growing number of leveraged ETFs have entered the market. According to Bogle, people who commit money to these products are "Fruitcakes, nut cases and lunatic fringe." He later says, "There's just no possibility or any realistic way that you're going to win that bet."
SEE: Leveraged ETFs: Are They Right For You
The Bottom Line
Jack Bogle started the Vanguard Group with the individual investor in mind. Vanguard continues to offer products that are among the lowest cost investment vehicles on the market, and experts routinely recommend Vanguard products to individual investors for use in 401(k)s, IRAs, and other retail accounts.
Bogle likes index ETFs, but using them as trading vehicles or as ways to beat the market is not a sound investing strategy, according to him. Mirroring the market instead of trying to beat it is how real money is made.
At the time of writing, Tim Parker did not own any shares in any company mentioned in this article.