How To Avoid Bad ETFs and ETNs
ETFs and ETNs are getting more popular, but you still need to be careful. Here’s how.
You probably own an Exchange Traded Fund (ETF) right now. You also probably know how easy it is to buy, sell or hold a sector, index, or basket of stocks disguised as an ETF. Click and it’s yours. You now own a cyber-security ETF that holds 15 stocks in the sector. But wait, let’s not get ahead of ourselves. It can’t be this easy, right? Each year, a lot of new investors get burned badly on ETFs.
The name of an ETF or ETN is not always representative of what the ETF does. For example, just because it has the name “oil” in it does not mean the instrument perfectly tracks oil. You need to dive deeper. Every ETF has a prospectus and that essentially explains what the purpose of an ETF is. If you don’t read the prospectus, well, good luck. You could be buying something really weird.
Let’s look at the ETF that trades under the ticker USO. That ETF is called the United States Oil Fund. If you’re an average investor just trying to buy some oil, you might do some research and stumble across this ETF thinking, “that’s perfect, I want to buy some US oil!”
But USO is actually a terrible long-term investment if you’re trying to buy and hold oil that’s drilled and refined in the United States. Like absolutely horrendous. Here’s a chart that shows you everything you need to know... and get ready. This chart shows the price of actual crude oil (black line) vs. the price of the United States Oil Fund ETF USO (red line).
What do you see? 🙈
That divergence looks bad. And yes, people are still holding USO thinking they’re buying crude oil for the long term. The good news, though is this, you can avoid this trap by doing one simple thing — READ the prospectus. Here’s what the creators of the USO ETF wrote in their prospectus:
“Investors should be aware that USO’s investment objective is not for its NAV or market price of shares to equal, in dollar terms, the spot price of light, sweet crude oil or any particular futures contract based on light, sweet crude oil, nor is USO’s investment objective for the percentage change in its NAV to reflect the percentage change of the price of any particular futures contract as measured over a time period greater than one day.”
So yeah. The fund, despite its name, is admitting that it does not track the spot price of oil. You aren’t buying crude oil with this fund — nope, not even lose.
That’s only one example. The list goes on.
I recently met someone who lost $17,000 trying to buy the UWTI ETN, which was a 3x Long Crude Oil ETN. They saw the name and immediately assumed “Oh wow I could triple my returns if oil climbs!” He went all in with $17,000. UWTI was recently delisted and removed from markets altogether. He basically lost everything. The problem is that this fund was fundamentally flawed and only supposed to be used as a day trading vehicle. Had you read the prospectus, you would have known this was not a long-term investment.
The graveyard of sketchy and scamming ETFs and ETNs is getting bigger by the day. What about VXX, which is the S&P 500 VIX ETN? No, it does not track the VIX perfectly and its prospectus essentially admits to the long-term dangers of buying it. There is a section devoted to these risks, don’t ignore it.
And the list goes on and on while the simple lesson stays the same: before you buy any ETF or ETN you need to read its prospectus. Its name is not a guarantee of its purpose. All the things you need to know are in that prospectus and you can find it on ETF’s website or by typing it into a search engine.
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