Clients may have a difficult time understanding the complexities of ETFs. That’s why it’s the advisor’s job to carefully explain how these funds work.
“ETFs are, in many cases, much more complex vehicles than most people realize, whether they are regular individuals or even advisors,” says Tim Maurer, a CFP and the director of personal finance at Buckingham Asset Management and the BAM Alliance in Charleston, S.C. “You should be able to explain this to a fifth grader, and I say this to financial advisors, too.”
Maurer said that he has seen advisors surprised at how some ETFs have performed.
“That’s because the ETF was not actually holding the securities it was meant to track but because it was holding derivatives,” he says. “If you don’t fully understand something and if it acts in a way that you’re not pleased with, you’re going to be more likely to throw your hands up and part with it.”
Advisors face an abundance of products, including ETFs, said Maurer, but they shouldn’t just succumb to the temptation of the popular.
“There are absolutely good reasons to utilize ETFs, but I would encourage advisors not to just do it because it appears to be a fad,” he says. “Do it because they inherently benefit your client.”
Maurer emphasizes to clients that though there are many market factors over which advisors have no control, ETFs help allow control of fees and tax liabilities.
When clients grasp exactly why ETFs make sense and how they actually work, it helps advisors manage expectations, he says.
In order to do that, advisors need to assess each ETF as they would any other investment vehicle, says Marie Dzanis, senior vice president and head of intermediary sales at Northern Trust in Chicago.
Advisors should find out how the asset manager came up with the strategy, how the ETF aligns with client goals and fits into a portfolio, and whether assets need to be moved around to accommodate the investment, she said.
“The No. 1 thing that clients hate is surprises,” Dzanis says.
“Advisors do not have a problem explaining how they took a bet and the market was against that bet,” she says. “They do have a problem when they say they incorporated a strategy that didn’t perform how they expected due to unforeseen reasons.”
Paul Hechinger is a contributing writer for On Wall Street.
This story is part of a 30-30 series on smart ETF strategies.