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Where ETF Industry Falls Short

Nate Geraci

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by Nate Geraci, president of The ETF Store Inc. and Host of ETF Prime.

 

In 2011, I was meeting a friend at a packed coffee shop when the conversation veered into a slightly heated debate over whether the average person knew what an ETF was. My stance was that few people were familiar with the investment product.

After becoming emboldened by one too many cups of coffee, I decided to settle the argument by approaching unwitting customers at nearly every table and simply asking, “Have you ever heard of an ETF?”

The result? Not a single person had any idea what I was talking about. An investment vehicle with so many potential benefits was unknown to everyday people.

Fast-forward to several weeks ago, where I found myself in a brief conversation with an individual trader at the Inside ETFs conference. ETFs have grown up since 2011, with U.S. assets rising to nearly $4 trillion, from $1 trillion eight years ago. Surely everyone knows what an ETF is, right?

Well, that trader politely conveyed that ETF geeks like myself operate in an echo chamber, and the ETF industry needs to do a better job of bringing our message to everyday investors.

Democratized Access But Not Financial Literacy

That interaction left an impression on me, and the more I thought about it, the more I realized she was right. In our cozy little industry circle, we toss around terms like strategic beta, factors, ESG, expense ratios and creation/redemption with the assumption everyone knows what these are.

We all like to talk about the mainstream adoption of ETFs and the wonderful innovation and how great ETFs are for investors. But 49% of people don’t even know what an index fund is. ETFs have democratized investing, but they haven’t democratized financial and ETF literacy.

A lack of education is a significant problem as ETFs continue pushing into the mainstream. If investors don’t understand ETFs, they won’t use them, and may forgo potential benefits like lower costs, tax efficiency, portfolio diversification, transparency and trading flexibility.

Other investors might not understand ETFs but still decide to use them incorrectly. Another group of aspiring ETF users might be scared away from ETFs due to sensationalized, negative ETF stories in the mainstream financial media (see here for “exhibit A”). All are bad outcomes for investors and the ETF industry.

ETF Education

Every week, ETF.com’s Dave Nadig fields questions during a live online chat. The topic of ETF education came up:

 

 

Dave is right. Because ETFs are now more commonplace, there’s a risk the industry simply assumes investors understand them.

ETF: Young Veterans

ETFs are at a unique point in their life cycle. On one hand, ETFs have been around for 25+ years, and there’s no question more investors grasp ETFs than they did in 2011. On the other hand, ETFs still feel new and innovative. They’re like a game-changing technology that people are just now realizing exists.

While the innovation is exciting, it’s also a doubled-edged sword. Investors can now build portfolios in a multitude of ways. They can also inflict damage on their portfolios in a multitude of ways—both of which brings us back to ETF education.

Path To Better Educate

For investors to achieve the best outcomes, ETF education is critical, and something every one of us in the industry needs to take more seriously. That starts with improving ETF knowledge within the industry.

In a recent survey of professional U.S. investors, 13% said they don’t fully understand ETFs, and 17% don’t know how to pick ETFs. We’re talking about institutional investors, financial advisors and fund managers.

 

ETF_echo_fig2


(For a larger view, click on the image above)

 

Cerulli surveyed financial advisors who currently don’t use ETFs and found the single biggest factor that would drive greater use is more education.

 

ETF_echo_fig2


(For a larger view, click on the image above)

 

If people within the financial services industry don’t fully understand ETFs, how can we expect individual investors to appreciate them?

The education gap for industry professionals and individual investors isn’t limited to ETFs. Our country has a significant financial literacy problem. If someone doesn’t understand the basics of personal finance, they simply aren’t going to understand ETFs.

Investment News recently surveyed financial advisors on the topic of financial literacy and found that 78% strongly agree that financial literacy is an issue in our country, but only 41% are doing anything about it.

 

ETF_echo_fig2


(For a larger view, click on the image above)

 

Best Outcomes Begin With Education

It’s time to change. Everything. The ETF industry needs to focus education efforts on advisors as well as individual investors.

Investors need help if you want them to learn about your multifactor ETF. Advisors need to focus education efforts on end clients. Put your money where your mouth is.

People have busy lives. It’s great if you can argue on Twitter about stock buybacks, the value factor and quantitative easing. What are you doing to help investors understand the most important building blocks of successful investing?

There’s tremendous opportunity for everyone—the ETF industry, advisors and investors—to improve investment outcomes. It begins with better education.

I could not be more excited about the future of ETFs. To be clear, there are some excellent resources out there. But we can do more. We can do better. Investors still have trillions of dollars in ridiculously pricey annuities, “actively managed” (closet index) mutual funds, hedge funds and other investment products designed to enrich salespeople or fund managers.

That’s opportunity.

Follow Nate Geraci on Twitter @nategeraci.

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