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Bogle: Stay Away from Risky ETFs

By Dan Weil   |   Tuesday, 12 Feb 2013 12:20 PM

Exchange-traded stock funds (ETFs) are seeing a huge inflow of capital, and John “Jack” Bogle, founder of The Vanguard Group, warns against getting involved with the riskier parts of that space.

Almost 70 percent of the new money going into stock funds now goes to ETFs.

Bogle breaks down the ETF universe into three categories. The first is broad market indices. “Who can be against that?” he tells Yahoo.

Editor's Note: How You Lost $85,000 During the Last Decade. See the Numbers.

“If you want to buy and hold the entire U.S. stock market or bond market or international markets, buying and holding it, here at Vanguard, we're indifferent on the ETF versus the traditional index fund we have,” Bogle tells CNBC. “Performance will be identical.”

The second category consists of ETFs focusing on individual industries or foreign countries. “I think that’s too narrow for most investors to fool with,” Bogle tells Yahoo.

“The last third is fruitcakes, nut cases and the lunatic fringe,” he explains. If you buy a triple-leveraged stock fund betting on stocks rising or falling, “there’s just no possibility you’re going to win that bet.”

One problem with ETFs is that about 75 percent of them are held by financial institutions, Bogle says. So turnover is very high, about 8,000 percent for the most popular funds.

“They can play games in ETFs that they can’t play elsewhere,” such as hedging and short selling, he tells Yahoo.

But aren’t the more esoteric ETFs perfectly fine for investors willing to do their homework on these funds?

“That's a big if,” Bogle tells CNBC. “Investors traditionally look at past performance and make their choices.”

The real issue is fees, he says. Many of the specialized ETFs have fees of about 1 percent. “You have no way management can beat that, because these are index funds,” Bogle tells CNBC.

“So you lose to your index almost by definition. … Over five years or 10 years, that's a killer.” By contrast, Vanguard index funds have fees of about 0.1 percent, he notes.

Meanwhile, Laurence Fink, CEO of BlackRock, the world’s biggest provider of ETFs, says investors will continue sending money to passive ETFs rather than actively managed mutual funds as they jump back into the stock market.

“What we are seeing, and the industry overall, are still a majority of flows moving more into passive,” he tells Bloomberg.

But it’s not that he sees a blazing rally for stocks. “I’m not here to say people are bullish and re-risking,” Fink says. “If they’re not bearish on the world, but not bullish, they probably have over-allocation to bonds, and they’re probably looking and re-orienting that.”

The first ETF, the SPDR S&P 500, began 20 years ago, and the vehicles are now an integral part of financial markets, with almost 1,500 funds holding more than $1.4 trillion in assets, The Wall Street Journal reports.

“At first, investors were highly skeptical of ETFs,” Chuck Simko, a portfolio manager at MainStreet Advisors in Chicago, tells the paper. “Now, they don’t even think twice about using them.”

Editor's Note: How You Lost $85,000 During the Last Decade. See the Numbers.

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