The words of investment guru Warren Buffett are ringing in the ears of ETF critics, questioning the role of many new exchange-traded fund products. Since Buffett, helmsman of Berkshire Hathaway (BRK.A), suggested that traditional low-cost index mutual funds might be more appropriate for portfolios than ETFs, a host of new exchange-traded products have hit the market with mixed results.While ETFs have introduced transparency and liquidity to the fund business while adding a wide range of low-cost products, problems have emerged as average investors embrace the funds. Overtrading, illiquidity and inappropriate funds have plagued shareholders, raising Buffett's 2007 concerns once again as investors leave index mutual funds for the open market.
Many of the popular leveraged ETFs, such as blockbuster Direxion Daily Financial Bear 3X Shares ( FAZ) and Direxion Daily Financial Bull 3X Shares ( FAS), are intended for use by sophisticated, active traders. Jim Cramer has noted that in the hands of regular investors, these leveraged ETFs can be "weapons of destruction.". Options on Buffett's Berkshire Hathaway B Shares ( BRK.B) began trading on June 17, highlighting another investment strategy previously shunned by the maven.
"Usually, if you want to buy or sell a stock, you should buy or sell the stock," Buffett noted at Berkshire's 2008 annual meeting. "Using options, four times out of five you will be right, the last one you'll miss. I've virtually never used options as a way to enter or exit a position." Buffett's recent investments include General Electric ( GE) and Goldman Sachs ( GS). While Buffett may not have warmed to ETFs in the past, the new options action may suggest hope for other investment vehicles. Still, everyday investors may be better off sticking to broad-index ETFs or, per Buffett's suggestion, broad mutual funds. Low-cost ETFs have brought transparency and liquidity to the fund marketplace. Just because you can trade an ETF minute to minute, however, doesn't mean that you should. ETFs offer access to sectors and asset classes previously unavailable to all but professional investors. Does this access, however, come with a price? As more ETFs flood the market with increasingly complex methodologies, it will be up to investors to discern which products are viable or not. Those who do not have the time or will to fully understand ETFs should seek out an investment adviser who specializes in these products or stay close to the sidelines with index funds.