Here’s Why You Need To Be Careful of ETFs and ETNs
Every great invention has its flaws, especially in finance.
You probably own an Exchange Traded Fund right now. You also probably know how easy it is to buy, sell or hold a sector, index, or basket of stocks. Click and it’s yours. Boom. You now own a cyber-security ETF. It holds 15 stocks in the sector. But wait, let’s not get ahead of ourselves. It can’t be this easy, right? Every 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. Just because it has the name “oil” in it does not mean it perfectly tracks oil. You need to dive deeper. Every ETF has a prospectus, and that essentially explains what any given ETF tracks and how it trades. If you don’t read the prospectus, well, good luck. You could be buying something really weird.
Take a look at the ETF $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 search for things like “crude oil ETF” or “crude oil fund.” One of the top results for both of those searches is the $USO ETF.
But $USO is a terrible long-term investment if you’re trying to buy and hold oil. Like absolutely horrendous. Here’s a chart for you. Get ready. It shows the price of crude oil (black line) vs. the price of the United States Oil Fund $USO (red line).
What do you see? 🙈
That looks pretty bad. And yes, some people are still probably holding $USO thinking they’re long crude oil. The worst part? They actually timed the bottom perfectly and still lost money. But there’s some good news. Anyone can avoid this trap. Just read the prospectus. In this example, here’s what $USO says:
“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.
But that’s not the only example.
I recently met someone who lost $17,000 trying to buy $UWTI, which was the 3x Long Crude Oil ETN. They saw the name and immediately assumed “oh man I could triple my returns if oil climbs!” He went all in with $17,000. $UWTI was recently delisted. He basically lost everything. That ETN suffered from a similar problem to $USO. In-fact, here’s how the chart looks… from $6,000 per share to $24.59:
Or 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.
The list goes on. And on. But the lesson stays the same.
Before you buy any ETF you need to read its prospectus. Its name is not a guarantee of its purpose.