Abusing ETFs

What is it about?

Using data from a large German brokerage, we find that individuals investing in passive exchange-traded funds (ETFs) do not improve their portfolio performance, even before transaction costs. Further analysis suggests that this is because of poor ETF timing as well as poor ETF selection (relative to the choice of low-cost, well-diversified ETFs). An exploration of investor heterogeneity shows that though investors who trade more have worse ETF timing, no groups of investors benefit by using ETFs, and no groups will lose by investing in low-cost, well-diversified ETFs.

Featured Image

Why is it important?

ETFs are the most exciting innovation in finance in the last 20 years. Properly used, they benefit everyone. However, individual investors may be tempted to use ETFs for market timing and, like their record on stock picking, their timing may be poor. This is what we find. ETF use actually make the individual investors in our sample worse off. This is the first paper to document this. The paper was featured in the Wall Street Journal on February 28, 2014.

Perspectives