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Simple is best. ETFs are not simple enough.

Posted by John Reed on

Reed’s rule #1 in my Reed’s Rules of Real Estate Finance

Is “Simple is better than complex.” Those rules are in my book Fundamentals of Real Estate Finance.

Many readers of my book How to Protect Your Life Savings from Hyperinflation & Depression, 2nd edition, have asked what I think about using ETFs to hedge against USD hyperinflation.
I said I did not like them because they are unnecessarily complicated and because they have a higher degree of political risk—maybe huge political risk. I was also concerned that they are relatively new and have not been tested in multiple crises.

Well, they got tested earlier this week and they did not do well. Turns out, they are hard to sell during crises and they are less desirable than the “underlying” assets upon which they are side bets.

I put “underlying” in quotes because the Wall Street Journal uses that word when talking about ETFs, but, by definition, there are not assets, underlying or otherwise in ETFs. They are derivatives, which means they are to the “underlying assets—stocks, bonds, and commodities—what a betting ticket at a race track is to owning the horse on which the bets have been placed.

For example, a Vanguard Consumer Staples Index stock fund went down 9% this week. But the Vanguard Consumer Staples Index ETF that referenced the fund dropped 32%. “Referenced” is the correct word, not “underlying.” In theory, the ETF moves in lock step with the Index fund that owns the actual stocks in question.

Why did they not go in lock step? Technical reasons like automatic trading halts, inability to know that the current value of the ETFs was. They were less liquid than the referenced stocks.

Politically, politicians don’t like the mess with commodities (farmers), stocks (Apple and its products and employees) or bonds (mortgage borrowers, retirees). But do they have any such qualms when it comes to restricting or punishing ETF owners who are like the mob at the betting windows of a race track?

To hedge against inflation, I recommend hard assets and selected foreign currencies. Hard assets are things like your home, car, vacation home, long-shelf-life food (a.k.a. commodities). I prefer that you invest in hard assets that you can use personally or sell. But you cannot eat real estate so I also recommend foreign currency for liquidity. The ones I recommend are AUD, CAD, NZD, CHF, DKK, and SEK. With the first three, I have and recommend savings accounts in the country in question. In the case of the last three, I have and recommend holding those in cash in a safe deposit box in Canada.

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