Instead of using ETFs only as an alternative to mutual funds for their retirement goals, investors are increasingly trading them for short-term gains.
ETFs are gaining traction and no longer viewed solely as a buy-and-hold investment for a retirement portfolio. Two out of five investors believe that ETFs should be used as trading mechanism than for long-term investing, according to a survey conducted by E-Trade Financial (ETFC), a New York-based brokerage firm.
Only one in four investors believe ETFs should be used as long-term investment, a change from the traditional belief that they mirror indexes. The survey included 954 self-directed active investors who manage at least $10,000 in an online brokerage account, trade anywhere from once a month to weekly and included 65% males and 35% females.
Retail investors now have more access to investments such as emerging markets, foreign equities and commodities through ETFs that used to be reserved solely for institutional traders, said Rich Messina, a senior vice president of investment product management for E-Trade.
"Many investors are using these ETFs opportunistically for short-term trading strategies," he said.
Investors are drawn to the fact that ETFs are often more flexible, liquid and transparent than other investments and give them the option to take a position on a certain belief or strategy, allowing them to "move in and out, in the event markets start to go in one direction or another," Messina said.
All age groups, Millennials, Gen X-ers and Baby Boomers, agreed that the U.S. market index ETFs, dividend ETFs and sector-and industry-specific ETFs are their favorites, the survey found. Millennials were more interested in and willing to purchase more opportunistic ETFs like inverse, foreign currency, derivative ETFs, even though they are less popular and are riskier.
"Their longer investment horizons can beget a higher risk tolerance, which could be driving their interest in these ETFs, which may be viewed as too risky for those nearing retirement," he said. "These younger, more risk-tolerant investors may be looking to increase their exposure to these classes, but doing so in a manner that allows them to get in and out quickly, which is why ETFs are so appealing."
Many investors are using ETFs both for their short-term trading goals and retirement plans with three out of five investors who believe they are either somewhat long-term or somewhat short-term vehicles, the survey revealed. It appears that some investors are utilizing a hybrid strategy where passive ETFs help to capture general market returns and also sector and volatility ETFs to trade and generate short-term themes and potential gains.
Why ETFs Have an Advantage
Shares of ETFs trade on the exchanges throughout the market day and investors have the most current pricing, while mutual funds are priced at net asset value (NAV) once a day after the market closes. Buying shares of an ETF allows an investor to place limit order on trades, sell short, buy on margin and buy or sell options on many ETFs, said Don Shelly, a professor of practice in finance at the Cox School of Business at Southern Methodist University in Dallas.
Investors find ETFs to be appealing for short-term trading beause they can bet on markets, sectors and asset classes, he said.
"The ETF space is much more conducive to building a strategic asset allocation with the flexibility to make tactical decisions when opportunities arise," said Shelly.
Compared with the traditional stand-by of investing in mutual funds, ETFs have much lower expenses, brokerage costs, no sales charges and much favorable tax liability, said K.C. Ma, a CFA and director of the Roland George investments program at Stetson University in Deland, Fla.
Millennials and Gen X-ers are often more likely to choose a high risk-high return combination compared with retired investors who are seeking low risk-low return points, he said.
"This is why young investors like iShares Nasdaq Biotechnology Index (IBB) - Get Report or PowerShares QQQ Trust, Series 1 (QQQ) - Get Report and retirees like Vanguard Dividend Appreciation (VIG) - Get Report ," Ma said.
The range of ETFs include ones with short biases, using high leverage, "smart-factor" ETFs that built in automatic style/sector rotations and ones betting not on the direction of the market, but on the changes in volatility and were all created for investors for short-term opportunistic trades, he said. Many of them are generated double-digit returns in 2016 such as the iShares S&P Global Infrastructure Index (IGF) - Get Report , which has risen by 20% to 25% since the beginning of the year.
"Even if you had bought any health care ETFs eight years ago at a 15% premium, amid Obama being elected, there would have been another 150% return coming in the following eight years," Ma said.
An investor who wanted to bet, "against all odds, that the Federal Reserve would have not raised the interest rates since the 2008 market crash, your iShares Barclay 20+ Year Treasury Bond (TLT) - Get Report would have produced over 50% return for you," he said. "On the other hand, if you have chased Vanguard Dividend Appreciation VIG the day after the Brexit vote, you will have lost 9% just a week later. If you had sold the Dow futures during election night amid Trump's increasing winning chances, you would have lost over 700 points even before the market opened next day."
ETFs were designed to be an option for long-term asset allocation and using it as short-term speculative trading can be risky.
"Keep in mind, in the short term, every winning short-term ETF trade is matched with a losing ETF trade," Ma said.
Investors must be aware that ETF shares can trade for more or less than the value of the underlying holdings and discounts or premiums can enhance or reduce returns, Shelly said.
"Before purchasing an ETF, investors need to examine the average number of shares traded daily," he said. "Some ETFs have low-trading volume, so bid-ask spreads can be large for a sizable position."
Commodity ETFs often do not own the underlying physical commodity and pose more of a risk. The ETF managers purchase futures contracts, so a crude oil ETF may or may not increase in value when spot prices rise "because the futures contract may not move at all or in some cases in the opposite direction," Shelly said.