Teeka Tiwari

Beware of 'Frankenstein ETFs'

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You may have caught the recent article in The Wall Street Journal that sang the praises of "managed" exchange-traded funds (ETFs). But don't be fooled. These "new" financial products are really just old-fashioned mutual funds disguised as ETFs.

You see, the mutual fund boys have been hemorrhaging cash, as the ETF market has exploded in popularity. ETFs have just a fraction of the cost of a mutual fund and are infinitely more flexible. You can sell an ETF short, and you can also buy or sell options against it. Additionally, ETFs have immediate liquidity and utter transparency.

In other words, an ETF is truly the perfect investment vehicle.

As such, the guys running the "evil empire" back in mutual fund land are mad as all get out and want to get their cut of the action. So, their brilliant solution is to create "stock-picking" ETFs that are managed by their fund managers.

A group out of San Francisco is introducing "actively managed" financial, large-cap technology and growth ETFs, although a few other groups have also made the foray into what I call this "Frankenstein ETF" market over the past year.

This is such a bad idea on so many levels that I don't know where to begin, although the guys over at ETFdb.com summed it up nicely when they wrote, "If football is a game of inches, investing is a game of basis points, and a manager's ability to execute trades at a favorable price may be just as important as his ability to pick stocks."

Why You Should Stay Away From 'Stock-Picking ETFs'

OK, let's first take a look at costs. A typical ETF has a management fee of about 0.25%; some are a little more, and some are a little less. These new mutual fund "Frankenstein ETFs" will have fees that range from 0.79% to 1.5%!

The effect of those fees over the life of a retirement portfolio is MASSIVE. Make no mistake -- if you are paying an extra point a year on a $100,000 portfolio over 30 years, it adds up.

Chew on this for a minute: $100,000 compounding at 11% for 30 years gives you $2,289,229.66.

But if you get clipped for an extra point a year in fees after 30 years, that number gets knocked all the way down to $1,744,940.23. That's over a half-million-dollar hit!