Are ETFs the Next Bubble?

by: Tom Lydon

ETF bubbleWe’ve seen bubbles in tech/internet stocks, real estate and maybe commodities, but could exchange traded funds be the next victim of a bubble?

According to Yale economist Robert Shiller, there are seven indicators for recognizing an asset price bubble, as stated in TheStreet:

  • Dramatic increase in the price of an asset
  • Consequent public excitement about the increase
  • Additional media hype
  • Stories of certain people getting rich, which generates envy among others
  • Greater public interest in the asset class
  • “New era” theories that justifies the price increases
  • Decline in lending standards

There are currently round 800 ETFs, and there are 552 new ETFs in registration. In 2009 alone, ETF assets under management increased 45% and ETF trading jumped 10%. ETFs offer sector and market diversification, low costs and liquidity in areas otherwise inaccessible to the average trader.

Are ETFs really in a bubble, though? Yes, there’s certainly a media frenzy, but what if it’s for the right reasons? After all, ETFs are on average cheaper than mutual funds and most actively managed underperform their benchmarks over time. Why not get excited about ETFs?

ETFs have a better chance of tracking their underlying indexes and by making the switch, you can save an average of 1% a year. Multiply that over decades of investing, and that’s significant.

ETFs promote trading, yes, but you can trade mutual funds, too. We’re all grown-ups, of course, and if investors are going to shoot themselves in the foot, ETFs are not going to be the bullet. There are all kinds of bullets out there, including stocks, mutual funds, futures, currencies and more. The point is, ETFs aren’t the only security that can be misused.

Right now, ETFs represent about 7% of mutual fund assets, but we sure wouldn’t mind seeing that number grow.

For more information on ETFs, visit our ETF 101 category.

Max Chen contributed to this article.

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