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Managing Your Divvy ETFs

A Great ETF Name Doesn’t Mean a Great Investment

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If you go back 30 or more years, you’ll remember that mutual funds were all the rage. They were (and still are) a way to invest in a basket of stocks around a central theme (like a sector) without taking on the risks of individual stock picking. While mutual funds still exist today in many retirement plans, they have largely been overshadowed by smaller, more nimble and edgy exchange traded funds (ETFs). In many cases where there is still a well-performing mutual fund, an equivalent ETF has been created by the same investment firm.

The 800-lb gorilla Vanguard has the Total Stock Market Index Fund Admiral Shares — better known as VTSAX to informed investors. With assets under management (AUM) of over $1 trillion, this mutual fund has been around since 1992 and gives investors exposure to small, mid, and large cap growth and value stocks as the name implies. In other words, the whole stock market including the favs like Microsoft, Apple, and the rest of the Magnificent 7 are in this fund.

So, if you believe the stock market will always go up and to the right in value and don’t want to think about investing, you can put your money in this one fund and then check it in 20 years.

The problem is that the fund holds over 4,000 stocks and the minimum investment is $3,000. It’s designed for people with large retirement savings, who don’t plan on trading in and out of the fund.

Alternatively, Vanguard created the Total Stock Market ETF (VTI) which almost mirrors VTSAX but has the huge advantage of being tradeable in your brokerage account, whether its Robinhood or some other brokerage. And at $245/share (as of February 14, 2024) it is much more accessible to someone looking to invest into the market that may not have a big retirement account at work.

ETFs, for all purposes, seem to be the best of all worlds — giving you diversity, while being much easier to buy and sell, along with all the other attributes that come with stocks like options trading.

However, the ease with which ETFs can now be launched has created a marketplace where ideas are sometimes thrown at the wall to see if they stick. Silly names, pop-culture themes, and ETFs to bet against a stock market influencer have now become normalized.

This has unintended consequences for long-term dividend investors looking for reliable ETFs that will be around in 10, 20, or more years.

Just a small sample of ETFs show that maybe we’ve had too much of a good thing:

KINGS — An ETF created to give investors exposure to dividend paying companies that have increased dividends for at least 50 consecutive years. A play on the term “dividend kings.”

COWZ — An ETF that pulls from the Russell 1000 index those companies with good free cash flow. A play on the term “cash cow.”

MOAT — You guessed it; an ETF that gives exposure to companies with wide moats (limited competition and huge barriers to entry). Salesforce and Disney make up large holdings in this ETF.

BUG — An ETF that tracks companies in the cybersecurity space. There’s also CIBR.

CLOU — Tracks cloud-based companies like Wix, Zscaler, Workday, Fastly, and more.

And there’s no shortage of cute names to take advantage of the burgeoning marijuana industry. ETFs like CNBS (cannabis), YOLO, and TOKE, are all real investments you can buy.

SARK — SARK was created to bet against Cathie Wood’s ARKK ETF, which people felt was a long-term bad investment. Critics felt the famed fund manager had gotten lucky with her Tesla pick and couldn’t repeat her success. The result was a fund to bet against all of her picks assuming she would eventually be wrong.

LJIM — The Long Cramer Tracker ETF was designed to pick stocks recommended by Jim Cramer, host of CNBC’s Mad Money Show. Only after 5 months of being in the market it was shuttered because not enough investors put money into the ETF (only $1.3 million).

However, the running joke for years has been that Cramer is terrible at picking stocks and you should always do the reverse of what he says. So, SJIM was developed by Tuttle Capital Management to bet against Jim Cramer’s picks.

The LJIM fund is reminder that even when coming up with novel ways to make a diverse selection of stock picks, these ETFs still cost money to run. There’s regulations, filings, reports and other metrics that have to be tracked and sent to investors and government agencies.

Recently, I was on the wrong end of investing in one of these novelty ETFs. Luckily, I had less than $1,000 USD in the fund as I was treating it more as an experiment.

Screenshot from email sent by SoFi on the closure of some of their ETFs

WKLY, by SoFi was designed to give you weekly dividends by picking quality dividend-paying companies based on the dates they normally pay quarterly dividends. By picking stocks that distributed dividends on staggered weeks, SoFi was able to build an ETF that paid me dividends every Thursday.

Note: you should never pick a company based on what week they pay you dividends, but because all the picks were good companies, I was curious to see how the fund would perform.

I was slightly up a meager 1% when SoFi notified me this month they would be shuttering the ETF. I assume for similar reasons like the Cramer one, not enough interest (i.e. cash inflows).

So, What Happens When an ETF Closes?

My immediate fear, and the inspiration for this story, was that the ETF would drastically drop in value as investors would rapidly sell their shares to get out before the close date.

The good news with many of these ETFs is that the price doesn’t just fall off a cliff if they’re about to get shuttered. This is not the case with single stocks when a company declares bankruptcy or decides to go private. The stock price can take a huge hit right after the announcement.

Because ETFs are tied to the value of their underlying stocks, in my case, companies like Broadcom, Exxon Mobil, Toyota, JPMorgan Chase, Cisco, Bank of America, the value of the ETF didn’t just crash the next day. All those underlying companies’ stock prices were doing fine.

When an ETF shuts down, shareholders receive a payout in the form of cash. The distribution per share is typically close to the net asset value per outstanding share at the time of closing.

However, this liquidation of the fund, in my case, the cost basis plus 1% gain, means you do have to pay capital gains tax as if you voluntarily sold the shares.

My 1% gain is a rounding error for the IRS but imagine if you were in an ETF that closed where you were up 20% with $100,000 USD in the fund. Now you’re talking about a big tax hit of thousands of dollars that you did not plan for.

Even if you’re not like me who overly obsesses about the tax man, this is a real consideration when picking an ETF to put your money into.

While I love the creativity that fund managers have embraced in creating new investment products, this must be balanced with the likelihood of success. There is only so much money sloshing around in the market, and when things go south, people tend to put their money into the tried-and-true ETFs that have been around. This leaves these novelty funds a quarter or two away from being closed.

So, as always, proceed with caution in where you place the bulk of your money.

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