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The Hidden Risks and Costs of ETFs

By WTOP Staff

Exchange-traded funds, or ETFs, are all the rage these days. There are thousands of them. According to the consulting firm PwC, ETFs now account for approximately $1.8 trillion in assets under management domestically. BlackRock is the industry leader, with almost $1 trillion in ETF assets. Other big players include Vanguard Group and State Street Corp.

ETFs and comparable index funds have a lot in common. Both invest in hundreds or thousands of stocks and bonds, permitting investors to obtain broad diversification through their purchase. Both are professionally managed.

There are also some meaningful differences. ETFs are traded on the major stock exchanges. The price of an ETF fluctuates during the course of a day. Mutual funds, including index funds, are priced once a day at the close of the market.

To purchase or sell an ETF, you need to open a brokerage account. Index funds can typically be purchased directly from the fund family.

Transaction costs are higher for ETFs than for index funds. You may have to pay a commission, and you will incur the cost of the “bid-ask spread,” or the difference between the highest buyer’s price and the lowest seller’s price, whenever you buy or sell an ETF. When you buy, you will pay the ask price. When you sell, you will pay the bid price.

Some brokerage firms, for example, Charles Schwab, Vanguard and BlackRock’s iShares business, offer programs with commission-free trades on certain ETFs. If you are relying on these programs, you should note that some firms limit commission-free transactions to only the ETFs they sponsor.

Index funds permit you to automatically reinvest dividends. There’s no automatic investment option for ETFs. The minimum investment required for ETFs is generally lower than the typical minimum investment for index funds. You can buy an ETF for the cost of a single share. Index funds often have minimums starting at $1,000.

Used correctly, ETFs can be a valuable part of your portfolio. However, many investors are misusing them and suffering the consequences.

The initial problem with ETFs is that, as I mentioned previously, you need to open a brokerage account to buy or sell them. Most brokerage firms make more money selling you actively managed funds than they do selling you ETFs. Once you open an account, you can expect a barrage of sales pitches for all kinds of other, often dubious, products. Assuming you’re able to resist the temptation to buy more products, you may still be lured into trading ETFs frequently based upon your broker’s “research.” This research will indicate that one sector is likely to outperform others. In my view, the fact that owning ETFs requires you to initiate a relationship with a broker is a compelling reason to avoid doing so.

Just because a fund is labeled as an ETF, doesn’t mean it’s not risky. There are a number of narrow ETFs, where the holdings are limited to particular countries and sectors. Buying these ETFs is a risky bet on the outperformance of that slice of the market.

There are also leveraged and inverse ETFs. Leveraged ETFs seek to return multiples of the performance of whatever index or benchmark they are tracking. Inverse ETFs, on the other hand, increase in value when the performance of the index or benchmark they track declines. Leverage and inverse ETFs track broad market indexes or currencies, commodities and sectors.

There are many problems with leveraged and inverse ETFs, including high risk, the chance that the fund will not meet its stated objective, high costs and less tax-efficiency than traditional ETFs. The U.S. Securities and Exchange Commission noted these additional risks for buy-and-hold investors in an alert.

John Bogle, founder of the Vanguard Group said he is concerned about the temptation to overtrade more narrow ETFs. He counsels investors to avoid altogether esoteric ETFs, such as leveraged and inverse ETFs, observing that’s where the “fruitcakes, nut cases and lunatic fringe” can be found.

If you want to simplify your investments, consider low-cost exposure to the global stock market. Vanguard’s Total World Stock Index Fund has an expense ratio of 0.30 percent. It is also available as a lower-cost ETF, Vanguard Total World Stock ETF, with an expense ratio of only 0.18 percent.

For the bond portion of your portfolio, consider exposure to both the domestic and international bond markets, such as the iShares Barclays Short Treasury Bond ETF and the SPDR Barclays Capital Short-Term International Treasury Bond ETF.

Now all you have to do is determine your allocation between stocks and bonds and rebalance periodically. Intelligent and responsible investing does not have to be complicated.

Dan Solin is the director of investor advocacy for the BAM ALLIANCE and a wealth advisor with Buckingham. He is a New York Times best-selling author of the Smartest series of books. His latest book is “The Smartest Sales Book You’ll Ever Read.”

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The Hidden Risks and Costs of ETFs originally appeared on usnews.com

Don’t Settle for Student Loans to Pay for Online Education

By WTOP Staff
Online college programs are becoming a more popular choice for prospective students, with one study finding that more than 6 million students enrolled in at least one online course in fall 2015. The popularity of these courses can be attributed in part to their flexibility with working adults' schedules, students' ability to progress more quickly through online programs and, oftentimes, cheaper tuition. [See 10 low-cost online bachelor's programs for out-of-state students.]Online degrees can be beneficial to many college students, but some studies have shown online learners complete their programs at lower rates than students at traditional brick-and-mortar campuses. Individuals with student loans but no degree comprise two-thirds of defaulted borrowers. Though these numbers are not encouraging, just like for traditional programs, there are ways to reduce how much you'll need to borrow for an online program to ensure you won't become one of these statistics. Don't just settle on borrowing student loans to cover the whole cost of your program and living expenses. Instead, start thinking about how to cut costs and cover your balance in different ways, such as the following. -- Grants and scholarships: Even though you are taking an online course, you can still apply and receive grants and scholarships. But your first step should be to complete the Free Application for Federal Student Aid, commonly referred to as the FAFSA, which will allow you to receive a Pell Grant if your expected family contribution is low enough. The EFC criteria and award amounts are adjusted annually, but the 2017-2018 academic year awards range from $606 to $5,920, which could significantly lower the amount you borrow annually. Your next step is to apply for scholarships. You can start by checking online scholarship search engines, such as the Salt Scholarship Search, College Board's BigFuture and Peterson's. But don't forget to take advantage of local organizations and your school's financial aid office. Both may offer scholarships that you can't find with a national scholarship search. [Review these 10 sites to kick off your scholarship search.]For instance, organizations like the Elks Club, Knights of Columbus or the Rotary Club typically offer scholarships annually to local students. Just because you're going to school online doesn't mean you're ineligible. Visit your local library for scholarship listings, and ask around town. You might be surprised how many local organizations offer scholarships. While these scholarships typically aren't large, every little bit counts. Each dollar you receive in a scholarship is a dollar you don't have to borrow and pay interest on. -- Work-study: Another option for online students may be work-study awards. Not all students enrolled in online programs are eligible, but students at some schools -- including, for example, SUNY Empire State College and Liberty University -- are. Work-study awards are not given upfront like scholarships and grants. In most cases, they are an offer to earn up to the awarded amount if you secure an eligible work-study job. While there is a misconception that all work-study jobs must be on campus, students can work for off-campus, nonprofit or public employers as long as the work is in the public's interest. You may be able to work for a for-profit employer if the job is relevant to your course of study. No matter who the outside employer is, it will need to have an established agreement with your college for you to receive work-study funds. Remember, to be eligible for federal financial aid, you must be enrolled and pursuing a degree or certificate. If you're not working toward a credential, Pell Grants and work-study won't be option, but you may still be able to take advantage of private scholarships -- just be sure to read the eligibility criteria carefully. [Explore what to know about financial aid in online programs.]-- Pay as you go: One of the great benefits to enrolling online is the flexible schedule, which can allow you to complete your college coursework around your responsibilities. But prospective students often overlook using their part- or full-time job earnings as an option for paying for college. Almost 80 percent of college students in 2015 worked at least part time while attending classes, according to the National Center for Education Statistics. By budgeting and thinking strategically about your college costs, you can likely reduce your dependence on student loans by paying a portion out of pocket. Many -- but not all -- online programs are less expensive than traditional programs and often have shorter payment periods. Six, eight or 10 weeks are common course durations. Because of the frequency of payments in an online setting, you may be well-placed to pay as you go and possibly avoid borrowing altogether. Attending college online and avoiding student loans may be challenging, but if you are willing to put in the effort, you can limit the amount you need to borrow. More from U.S. News Q&A: Understanding Student Loan Discharge Eligibility Student Loan Refinancing Isn't Right for All Borrowers
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