SAN DIEGO (ETFguide.com) - John Bogle hates exchange-traded
funds (ETFs). And he makes no bones about his dislike for these low
cost but heavily traded financial products.
In a new research piece just published by the Journal of Indexes
and IndexUniverse.com, Bogle argues that ETF investors are
self-destructing. His data evaluated 79 ETFs and showed that 68 had
investor returns that lagged the actual returns of the funds
themselves. Underperformance was particularly pronounced with ETFs
following emerging markets and narrow industry sectors.
While many financial professionals and investors (including the
author) view ETFs as an extension of his original index fund
concept, Bogle has been and continues to be an outspoken critic of
ETFs. Are John Bogle's criticisms warranted or is he wrong about
Before we evaluate his arguments against ETFs, let's evaluate
There's no questioning John Bogle's positive impact on investors.
As founder and former CEO of the Vanguard Group, Bogle almost
single-handedly turned an entire generation of would be market
losers into winners. For decades he's consistently warned the
investing public about the hazards of investment costs, taxes and
the risks of trying to second guess the market. He's the Paul
Revere of investing.
Bogle is also credited with helping to introduce the first
retail index mutual fund, a Vanguard fund benchmarked to the
S&P 500 (Nasdaq: VFINX). Today, VFINX is one of the top mutual
funds, with around $40 billion in assets. Bogle is also an
ETFs are bought and sold at market prices throughout each trading
session, whereas traditional mutual funds are bought and sold at
their net asset value (
) at the end of each market day. Bogle says this encourages ETF
investors to become traders of their investments instead of
Intraday liquidity is an important product feature of ETFs. It
gives investors a flexible entry and exit strategy by allowing them
to buy and sell shares when the financial markets are open for
In recent years, trading in ETF shares has exploded and many
funds, such as the SPDR S&P 500 ETF
ETF (NYSEArca: SPY) and PowerShares QQQ Trust (tracks the NASDAQ
100) (NasdaqGM: QQQQ) dominate the daily volume on major stock
It's a widely known fact that large institutions account for the
bulk of ETF trading volume. Before you believe the false argument
that ETFs have transformed an entire generation of investors into
hyperactive traders, it's important to have some context. The vast
majority of ETF trading volume comes from institutional investors
trading large share blocks, not mom and pop investors trading a few
Interestingly, individual stocks also have intraday trading
volume just like ETFs. Should we make the case that stocks should
be completely avoided because they have daily volume and might
induce investors to needlessly trade? Making a similar claim
against ETFs is irresponsible.
The Truth about Bid/Ask Spreads
Another point of contention against ETFs is their subtle trading
costs. Like stocks, ETFs have differences or spreads between their
bid and ask prices. Morningstar recently launched a helpful ETF
database that reveals the real trading cost of bid/ask spreads.
These costs are expressed in percentage terms. Generally speaking,
ETFs with lower trading volume tend to have larger bid/ask spreads
and consequently higher trading costs, whereas ETFs with higher
trading volume have lower bid/ask spreads and cost. Do bid/ask
spreads wipe away the low cost and tax efficiency of ETFs?
It's imperative to understand the cost impact of bid/ask spreads
is not exclusive to ETFs and that all exchange listed securities
(stocks, closed-end funds, ETNs, etc.) have this often overlooked
cost attached to them. But wait, there's more.
It's just as vital to recognize that mutual fund investors are
also impacted by the trading cost of bid/ask spreads too. That's
because fund managers are buying and selling stocks and other
exchange listed securities within their portfolios. In the case of
mutual funds, bid/ask spreads are an embedded cost that's not
reflected in the fund's expense ratio. It should also be noted that
traditional index mutual funds do not escape the cost of bid/ask
What Does Bogle's ETF Study
Bogle's latest study is less about ETFs and more about the problems
associated with investor behavior. The fact is many investors with
chronic behavioral problems and a general propensity to
self-destruct were that way long before ETFs arrived on the
investment scene. Demonizing ETFs is misplacing the blame.
Although Bogle's data argues that index mutual fund investors
get better returns compared to their ETF counterparts, mutual fund
investors are far from well-behaved. Dalbar reports in its
Quantitative Analysis of Investor Behavior that in 2008 stock fund
investors lost 41.6% compared to the 37.7% loss for the S&P 500
Used correctly, ETFs are wonderful investment products. Used
incorrectly, ETFs can be deadly. The issue of incorrect usage,
however, is not caused by ETFs or even a problem exclusive to ETFs.
Along similar lines, should we fault automobiles for car accidents?
How about we blame fire for burning people? And while we're at it,
shall we fault knives for cutting people? Likewise, saying that
ETFs induce investors to self-destruct is absurd. Investors are the
ones responsible for their own financial fate, not ETFs.
Unmoved by all counterarguments, Bogle's crusade against ETFs
continues. 'An ETF is like handing an arsonist a match.'
Still, it's hard to dislike John Bogle.
Even when he's wrong.