Why Your Fancy, New ETF Might Be Too Fancy
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What is the main topic discussed in this episode?
Listen at schwab.com slash washingtonwise.
Here's your Money Briefing for Thursday, January 16th. I'm Arianna Espuru for The Wall Street Journal.
Why did ETFs attract more than $1 trillion in U.S. inflows in 2024?
Investors put more than $1 trillion into U.S.-based exchange-traded funds, or ETFs, last year. And no wonder. They're cheap, liquid, and tax-efficient. But lately, Wall Street has been using ETFs to package various financial products that are increasingly obscure and complex.
As ETFs get more complicated, knowing whether they're attractive to you or whether you're the right person to use them or how to use them gets extremely difficult.
So what do you need to know about these new, fancier kinds of ETFs? We'll talk to Wall Street Journal Heard on the Street columnist John Sindreo after the break.
This episode is brought to you by Charles Schwab.
What is an ETF and how does it differ from mutual funds and stocks?
Decisions made in Washington can affect your portfolio every day. Washington Wise from Charles Schwab is an original podcast that unpacks the stories making news in Washington. Listen at schwab.com slash Washington Wise.
ETFs have been pretty good investments, but they might be getting too good.
How are Wall Street firms making ETFs more complex and why does that matter?
Wall Street Journal Heard on the Street columnist John Sindreo joins me. John, let's do a quick refresher first. What is an ETF and how does it differ from other investments?
So an ETF is a bit like an open-ended mutual fund, but they're far more beloved by investors because an ETF is backed by a bank or what's called an authorized participant that provides it with constant liquidity. The shares trade in exchanges so you can buy and sell them during the day. They're very tax efficient. because of the way that this redemption in kind works when a bank steps in to make sure that people match the supply and demand for those shares. So essentially, they are the biggest story in financial markets in the past couple of decades. And in 2024, they surpassed $1 trillion in total inflows in the U.S.,
How can complicated ETF structures create tax uncertainties for investors?
When the rest of Wall Street is now trying to find other ways to profit from ETFs or they're trying to package even pretty complicated products into ETF form because it's just what everybody wants these days.
You mentioned that record that ETFs broke last year, surpassing $1 trillion. Is that why they're so popular? Explain to me the draw that people have towards them.
It's tax efficient. It's liquid. And it's also, by virtue of all these things, it's a cheap product. It's a cheap vehicle. You pay lower fees on ETFs than you do on comparable funds. A big part of the whole passive investing rush of the past couple of decades has to do with ETFs. Even though ETFs are now branching into many other things. So there's active ETFs, there's ETFs that invest in complex derivatives, there's ETFs that are starting to invest in private markets.
What specific risks arise when ETFs use derivatives, leverage, or private assets?
So everything is now coming in ETF form.
In your story, you highlight a number of ETFs that look great, but haven't delivered on what they promised. What's causing this?
Well, there's a variety of potential issues that you could highlight once you start venturing outside of these very vanilla S&P 500 or Stocks Europe trackers. And I would argue that they all share in common that complexity makes things harder and more unpredictable. As ETFs get more complicated, knowing whether they're attractive to you or whether you're the right person to use them or how to use them gets extremely difficult. And In some cases, for example, we are even having ETFs that are promising to match returns of other assets in a tax-efficient way. And this might work out, but you also don't know what the IRS is going to say a few years down the line. You don't know whether they structure this correctly or whether you're going to get a tax bill down the line.
So again, a lot more small print that needs to be read and a lot more unknowns that will clear themselves out in the near future.
And as these ETFs become more complex in the coming years, what are some of the concerns that investors have?
much of the concern about them has to do with liquidity. That is the typical concern that has been thrown around whenever you mention ETFs.
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Chapters
8 chapters
1
What is the main topic discussed in this episode?
0:01–0:37
2
Why did ETFs attract more than $1 trillion in U.S. inflows in 2024?
0:37–1:23
3
What is an ETF and how does it differ from mutual funds and stocks?
1:23–1:47
4
How are Wall Street firms making ETFs more complex and why does that matter?
1:47–2:36
5
How can complicated ETF structures create tax uncertainties for investors?
2:36–3:24
6
What specific risks arise when ETFs use derivatives, leverage, or private assets?
3:24–5:55
7
Who are the appropriate investors for exotic or leveraged ETFs?
5:55–7:19
8
What due diligence should everyday investors perform to evaluate an ETF?
7:19–8:57
Speakers
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