Emotion-Traded Funds (ETFs) ?

Imagine that if you had bought the iShares Global Infrastructure ETF (NASDAQ: IGF) at the beginning of 2016, you would have made 20-25% by now, give or take 2-4 % if Clinton were elected.

Even if you had bought any health care ETF eight years ago, at a 15% premium already, amid Obama being elected, there would have been another 150% return coming in the following eight years.

Just before a month ago, if you had bet, against all odds, that the Federal Reserve would have not raised the interest rates since the 2008 market crash, your iShares 20+ Year Treasury Bond (NYSE: TLT) would have produced over 50% return for you.

On the other hand, if you had chased VIG the day after the Brexit vote, you would have lost 9% just a week later.

Ironically, even if you had predicted “correctly,” a year ago, that the Clinton’s drug price plan would never see the light of day, your longs in IBB, along with Dynamic Pharmaceuticals ETF (NYYSE: PJP) and US Pharmaceuticals ETF (NYSE: IHE) would have still brought you near 30% in losses today.

If you had sold the Dow futures during the Election night amid Trump’s increasing winning chance, you would have lost over 700 points even before the market opened next day.

Originally, ETFs were designed to track specific investment theses, such as different asset classes, investment styles, sectors or industries, currencies, and interest rates. Compared with the alternative of owning all the components directly, investing in the ETFs which “bundle” hundreds or thousands of stocks with a common theme is considered a more efficient way to deliver any combination of risk and return.

For long-term asset allocation, modern portfolio theory suggests that you probably need no more than a few dozens of randomly selected stocks to form an optimal portfolio which can deliver any possible combination of risk and return of your choice. Of course, the “efficient frontier” portfolio is the one which produces the highest return at the same risk level. All investors need to decide is which point on the efficient frontier they want to be at, based on the point on their life cycle.

If you are a young person, you may be able to choose the high risk-high return combination, versus the retired investors on the low risk-low return points. All ETFs are designed to locate on the different spot of the efficient frontier for your picking. This is why young investors like iShares Biotechnology ETF (NASDQ: IBB) or PowerShares QQQ ETF (NASDAQ: QQQ), and retirees like Vanguard Dividend Appreciation ETF (NYSE: VIG).

Compared with another alternative of investing in mutual funds, ETFs have much lower expenses, brokerage costs, no sales charges, and much more favorable tax liability. ETFs also have better liquidity, traded like stocks all through the day, while mutual fund shares can only be priced once at the end of the day.

The ease of use and the popularity stimulate finance industry creativity which has prompted the birth of many ETFs with themes which were traditionally only reserved for institutional investors. ETFs with short biases, ETFs using high leverage, “smart-factor” ETFs that have built in automatic style/sector rotations, and ETFs betting not on the direction of the market, but on the changes in volatility are all created for investors for short-term opportunistic trades.

The moral of the story is to be careful using a tool, which was originally designed for long-term asset allocation decisions, for short-term speculative trading.

Keep in mind, in the short term, every winning short-term ETF trade is matched with a losing ETF trade.

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