Buffered ETFs – Worth the Hype?

Written by: Andrew Briesacher, CRPC® – Wealth Manager

Here at Wheelhouse Advisory Group, we aren’t a team that jumps on a new trend without thorough research and investment discipline; however, we do think it is important to stay on top of new ideas and products so that we fully understand how they operate in case opportunities arise for our clients, or they or our prospective clients have questions.

While over the last 10-15 years, ETF’s have become a more popular option for diversified cost-effective investing, they are not all created equal. Recently, many families and individuals have inquired about a trending topic, “Buffered ETF’s.” As always, we think it’s important to weigh the pros and cons of these investments before making any rash decisions or portfolio changes, and while we are not opposed to these new ideas, Wheelhouse Advisory Group does want to be cautious with new ideas before jumping on the bandwagon.

Here are some of the Pros and Cons of Buffered ETF’s:

PROS

• Downside Protection: Buffer ETFs aim to provide some level of downside protection during market dips. They use derivatives or other hedging instruments to limit losses within a specific range, this can be appealing to investors who are risk-averse or concerned about potential market declines.
• Defined Risk Exposure: Buffer ETFs offer a predetermined level of protection, usually expressed as a percentage buffer. This can help investors better understand their potential losses during adverse market conditions and set appropriate expectations.
• Diversification: Like traditional ETFs, Buffer ETFs typically hold a basket of underlying securities, providing investors with diversification benefits and reducing individual stock risk.
• Lower Costs: Buffer ETFs can be more cost-effective than actively managed funds because they usually follow rules-based strategies rather than requiring constant adjustments by portfolio managers.

CONS

• Limited Upside Participation: The protection provided by Buffer ETFs comes at a cost – potential limited upside participation in strong bull markets. The buffer cap (the maximum return level) could prevent investors from fully benefiting from significant market gains.
• Complexity: Some buffer strategies can be complex to understand due to the use of derivatives and various hedging mechanisms. Investors may find it challenging to grasp the full implications of these strategies.
• Tracking Error: Buffer ETFs might experience tracking errors due to the implementation of their buffer strategies. These discrepancies can lead to differences between the fund’s performance and the underlying index or benchmark.
• Expense Ratios: While Buffer ETFs can be cost-effective relative to actively managed funds, they may still have higher expense ratios than traditional, passive ETFs, which could eat into overall returns.

Remember that the specific pros and cons of Buffer ETFs may vary depending on your portfolio, the underlying assets, and the market conditions. As with any investment, it’s essential to conduct thorough research, understand the strategy, and consider your risk tolerance and investment objectives before investing in buffer ETFs or any other financial product.

If you have questions about the specific investments or strategies used in your portfolio, or would like a second opinion on your current retirement plan please contact our team today, 636.400.7889.