Why ETFs are a scam

Cute title, the equivalent of the classic "SEX!!! Now that I have your attention..."

If ETFs are a "scam", then most managed funds with their bloated expense ratios that support huge bureaucraties, fancy offices and steak dinners for their managers should be called an "über-scam".

ETFs are good for broad market cap, fixed income or sector exposure. They are an excellent tool for the medium-sized portfolio (somewhere in the $100,000-$200,000 range) because of their low fees and transparency. For a portfolio less than that range, mutual funds with no trading fees are a good choice; if they are worth more, individual securities with 0 annual fees are probably a better choice than ETFs.

People are just trying to make it more complicated than it should be. I believe that ETFs should be used as the basic building blocks of a solid portfolio, but that still leaves some room for managed money and individual stocks/bonds for the more sophisticated or intrepid investor.

Do I believe the average Joe would do better with a balanced ETF portfolio (say, XIU/XIC, XSP, XIN and XBB/XCB) than with a mishmash of expensive funds? Yes.

As a portfolio grows, however, I believe ETFs should gradually be sold off and replaced with individual stocks/bonds, in order to completely eliminate annual expense ratios. This is what I will start to do within a year or two.

Steve19 said:

DrStan,

How many individuals stocks (after slowly liquidating your ETF's) do you plan on holding? More than one in each sector?

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Ideally, something like 5 or 6 of the top 15 holdings of any ETF I decide to sell. This will require some stock selection, and perhaps some market timing.

Here's an example. I hold about $40K of XDV (iShares Dividend Fund) in my non-registered account and I have $10K in cash right now. XDV has 30 holdings and it costs me $200 a year in MER (0.50%). I believe that I will be able to somewhat replicate its returns by selecting five or six of its holdings and owning them directly, with no further costs (something like NatBank; BMO; TD, Manitoba Tel; TMX and Sun Life) in lieu of the ETF. This allows for a bit of stock selection, ie. eliminating the index components I don't like.

I actually considered buying more XDV with my $10K in cash, but now I'm looking at two direct purchases of $5000 of its index components. $10K of XDV costs $50 a year in MER. These two trades would cost $20, which means that the cost would be offset in less than six months. It certainly is tempting, especially considering I have about a 30 year time horizon for any investment, plenty of time to rebalance and switch things around.

Caveats:
-I won't replicate the results of the ETF perfectly, and there could be significant variations.
-Yes, I could get burned if a couple of the holdings go down in flames (less downside protection than a diversified ETF).