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How Financial Advisors Use ETFs

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We looked at “How Investors Use ETFs” [4].

Today we consider how financial advisors use exchange traded funds (ETFs) in their business. 

How Financial Advisors Use ETFs

ETF Trends article, “How Financial Advisors are Using ETFs” [5], makes some good points.

ETFs Protect Against Deceptive Practices

ETFs tend to be low-cost instruments, with no commissions, retrocessions, kickbacks, etc., paid to the salesman by the fund.

“We’ve found that using ETFs as part of a passive portfolio management strategy provides a very effective shield against the deceptive business practices so prevalent in the retail funds industry.” Ric Edelmanan of Edelman Financial Services said.

The article does not really flesh out what constitutes “deceptive business practices”. I assume they refer to the potential for mutual fund salesmen to push products that provide the salesman with high commissions, rather than what may be the best product fit for the client.

Not all mutual fund representatives do this. But it does occur. You need to understand how the financial advisor is being remunerated to protect your own interests.

It all comes down to the commission based [6] versus flat fee [7] financial advising discussion. Be sure to know the pros and cons of both.

ETFs Aid in Objective Financial Planning

A client who is concerned as to whether a recommended financial product is the best fit for his needs, or simply the product that pays the advisor the highest commission, should worry as to whether he is obtaining objective advice.

“”The use of ETFs fits perfectly into an investment process where an advisor serves as an objective voice to help investors focus on their longer-term goals.”

You want an “objective voice” advising you on products that meet your financial objectives. ETFs, where the advisor is not earning a sales fee, can help ensure you are getting a low cost solution to your needs. Not a high priced product that may enrich the salesman, but might not be your best fit.

To improve the odds of getting objective advice, determine if your advisor is a fiduciary [8].

ETFs Assist in Benchmarks and Evaluations

An important part of investing is being able to assess performance [9] over time. On a stand-alone basis [10], as well as against predetermined benchmarks [11] and peer groups [12].

As the ETF industry matures, more advisors are able to put together a score card for an investment portfolio.

As a greater number of ETFs develop lengthy track records, it is easier for a financial advisor to compare performance over time against benchmarks and peer groups.

If lower cost ETFs [13] demonstrate they do outperform similar (but more expensive) mutual funds, clients will demand ETF inclusion in portfolios. This will cause open-end mutual funds to become more competitive on pricing [14], a benefit to investors (but not to fund salesmen).