Are ETFs Good or Bad?

by Finploris
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2021 was a record-breaking year for the ETF world. For the first time ever, inflows into ETFs world-wide have surpassed $1 trillion at the end of November 2021.

That wave of money brought total global assets in ETFs to nearly $9.5 trillion, more than double where the investment vehicle stood at the end of 2018.

This is unbelievable.

But it is also understandable why investors are doing this. Popular ETFs that track major indexes have made massive gains over the past several years.

The S&P500 Index ($SPY) is up over 400% since 2009.

SPDR S&P 500 ETF Trust (SPY)

Instead of wasting your time picking individual stocks, you can simply buy an ETF and realize enormous profits.

But is it really that simple?

I mean, if it was that easy to earn money, then everyone would do it.

Today, everyone is starting to do this… even institutional funds that typically use active trading strategies. They are turning to ETFs as a low-cost option to generate returns to their clients.

So where does the problem lie?

For right now, there isn’t a problem. The stock market is reaching record levels on a daily basis and ETFs correlated to these markets are making investors happy.

But, as I’ve mentioned before, there’s a risk with ETFs that investors aren’t taking into account.

In principle, an ETF buys its underlying assets regardless of price or valuation.

An ETF provides investors with a wide variety of different stocks, but that means nothing if all of those stocks are overvalued.

It only means that you own a bunch of overvalued stocks!

However, many investors are okay with that. They justify buying into an expensive market because “it doesn’t matter in the long run.

Here is their general thinking:

You can’t time the market, which means it’s better to get involved regardless of the price. Even though you will experience ups and downs, you will be fine in the long run.

What an opportunity!

But here’s the point: We can time the market. That’s what investing is all about.

We can’t time it exactly, but we can get fairly close.

For instance, the stock market is expensive in many ways now. Conversely, the stock market was cheap in 2009.

The risks of buying at a peak.

When things are going well (like now), it’s easy to believe that things will get even better. And when things are going badly (like in 2009), it’s easy to believe that things will get even worse.

We can only time the market by looking at the overall market cycles. We don’t know precisely when a market will bottom, and we don’t know precisely when a market will peak.

But we can make some pretty accurate predictions about market value. We can ascertain whether the market is very expensive or very cheap.

I would like to share with you two different scenarios for investing $100,000.

  1. Investment on September, 28th 2007
  2. Investment on March, 6th 2009
  1. In 14 years, you achieve a return of 192%.
SPY, September, 28th 2007

2. In 12 years, you achieve a return of 545%.

SPY, March, 6th 2009

If you had waited two years to start investing, you could have made $545,000 (vs. $192,000).

Of course, only if you caught the bottom of the market perfectly. In hindsight, it’s easy to identify the bottom, but things weren’t so clear at the time.

Also, in 2009, people literally believed that the entire financial system was going to collapse. That’s what usually happens during market collapses – people think the world is coming to an end.

Today, this is an almost unthinkable scenario. Consumer confidence is very high, and expectations are much more positive than in 2009.

In other words, are ETFs good or bad?

ETFs are a smart way to invest in a variety of different stocks. They usually have low fees and allow individual investors to get exposure to a large portion of an Industry. But…

The problem is which industry the ETF is targeting.

If you invested in a tech ETF in February 2021, for example, you probably bought a lot of stocks that were extremely highly valued.

On the other hand, if you had invested in a commodity ETF in August 2020, you would have bought a lot of shares that were priced very low.

Consequently, take a look at the ETFs you are currently invested in or thinking of investing in. What are the actual valuations of the underlying assets?

Are they overvalued or are they undervalued? 

If you look at the two charts above, you can understand the value of buying near a bottom rather than near a peak.

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