It’s been roughly a year since I introduced myself to the world of investing, and in that year, I’ve become a part of the wealth generation community. I’ve read countless articles and follow all of the newsletters that have taken up my time. One thing I’ve noticed is that a lot of the trends I’ve seen in the financial world are very similar to those that were written about in the startup world. There are only a handful of people that really know how to build a solid business, and the same applies to investing.
The idea of investing in ETFs has become very popular in recent years, and many investors are starting to add ETFs to their investment portfolios. But what are some of the benefits of investing in them? First, for those who are new to investing in ETFs, it is undeniably easier to buy ETFs and redeem them than it is to buy mutual funds. Since ETFs are index funds, you can buy them with a minimal amount of money and they are already diversified by all of the major stock and bond markets so there are no additional commissions or fees to pay.
Exchange Traded Funds (ETFs) have become a popular investment vehicle for investors large and small. This is mainly because they combine excellent fund diversification with the convenience of stock trading.
But like any other form of investing, ETFs have their drawbacks and should be viewed from an informed perspective.
To expand your knowledge base, let’s look at the pros and cons of investing in ETFs.
Spreading your assets across a wide range of securities is an effective way to increase your potential returns, and ETFs are an excellent way to achieve this goal.
As a series of stocks or bonds representing a wide range of regional and international markets and sectors, ETFs offer hundreds of ways to track and simulate the returns of everything from the S&P 500 to the biotech industry, from short-term bonds to the emerging market of a particular country.
ETFs make it easy to develop an investment style that suits your preferences and build a portfolio based on growth, income and long-term stability.
⇒ Investment advice: Are you looking for a diversified portfolio? ETFs are the best tool for diversification[/alert-note].
2. Handy trade
One of the main advantages of ETFs is that they can be bought and sold quickly and easily on the stock market at any time during the trading day.
Allows you to track the current and daily prices of an ETF, as well as trends in the market or sector it tracks, by simply looking up the assigned ticker symbol on an exchange’s website.
And unlike mutual funds, which must be purchased after the market closes and whose net asset value is recalculated, ETFs are highly liquid and allow you to react to the market in real time.
⇒ Investment advice: ETFs can be traded just like stocks[/alert-note].
3. Much cheaper than investment funds
When it comes to investing your hard-earned money, the relative savings that ETFs offer cannot be ignored.
Because they are more passively managed than mutual funds, exchange-traded funds have much lower management fees and thus much lower expense ratios.
With ETFs, you can avoid paying for active management techniques that in most cases do not lead to a profitable market.
If you are looking for brokerage firms and ETF providers with low or no fees, if you invest relatively large amounts, or if you stick to a buy-and-hold philosophy, you will have significantly lower fees with ETFs than with other managed index funds.
⇒ Investment advice: ETFs are 10 times cheaper than mutual funds[/alert-note].
4. Actions with tax break
Because they are designed to track the performance of a specific market index rather than beat the market they represent, the stocks held by ETFs are not constantly bought and sold like many mutual funds.
When a mutual fund sells a security at a profit, the resulting capital gain is distributed to its shareholders, which means they must pay the applicable tax on that income.
ETFs offer a unique and trackable investment structure that allows units to be transferred and repurchased as an in-kind contribution, eliminating the need for capital gains tax.
This simply means that you can defer most tax consequences until you sell the ETF, making them much more tax efficient than mutual funds.
⇒ Investment advice: ETFs are more tax-efficient than mutual funds[/alert-note].
1. Trade commissions
Although their management fees and expense ratios are much lower than most mutual funds, ETFs charge a commission each time you buy or sell.
They are therefore more expensive than individual shares, since there are no management costs for shares.
If you trade often, these costs can add up, reducing your investment return and negating the benefits of ETFs’ built-in cost advantage over actively managed funds. This is particularly true of no-load mutual funds, for which no sales commission is payable.
It’s important to compare all costs of comparable funds, including transaction costs, and realize that ETFs are much better for one-time purchases and long-term investments.
⇒ Investment advice: If you have to choose between stocks and ETFs, choose stocks or both[/alert-note].
2. Tracking error
The term tracking error refers to circumstances in which the ETF’s management company does not guarantee that the fund’s assets will fully match the performance of the index it is designed to track.
This bias is unavoidable to some extent and is generally related to cash allocation, as not all of the ETF’s financial assets are fully invested in equities at any given time.
Some assets of ETFs are still held in cash to pay various management fees and expenses, and the time lag between declaration and payment or reinvestment of dividends generated by some types of ETFs means that they will never track their target indices closely.
Sometimes ETF managers simply do not have access to the shares of illiquid securities held by their funds and, in order to rebalance their index funds, must resort to buying shares of similar securities instead.
All of these factors can cause the return of an ETF to deviate to some extent from the expected benchmark, which can incur costs that are inevitably passed on to the investor.
⇒ Investment advice: Only buy ETFs from leading ETF providers[/alert-note].
3. Distribution of capital gains
It is important to note that some types of ETFs distribute capital gains to shareholders as they are realized, so you must pay the appropriate tax on those gains.
In general, this is not an ideal situation for an investor, as it is often more profitable to defer taxes by automatically reinvesting the capital gains.
To achieve this goal with this type of ETF, you would have to use the distributed profits to purchase additional ETF units yourself, which would result in higher commissions and unwanted tax consequences.
⇒ Investment advice: Only buy ETFs from leading ETF providers[/alert-note].
4. Creeping increase in management fee
Over the years, new ETFs entering the market have gradually begun to charge higher management and administration fees. It is therefore essential to carefully examine and compare the expense ratios of the various index funds offered.
Typically, the increase in fees is due to increased competition from funds, marketing costs and index licensing fees.
⇒ Investment advice: Again: Only buy ETFs from the best ETF providers[/alert-note].
When you weigh up the pros and cons of investing in ETFs, the bottom line is that they can be a valuable addition to your long-term investment portfolio.
Provided you do your homework and consider the potential costs and tax implications, exchange-traded funds offer asset exposure, diversity, convenience and relative stability that are unmatched within the parameters of an equity market investment.
Frequently Asked Questions
What are the drawbacks to ETFs?
ETFs are not always the best investment for every investor. Some investors may prefer to use mutual funds because they are more flexible.
What are the main benefits of investing in ETF?
ETFs are a type of fund that invest in a basket of stocks, bonds, or other assets. They are traded on stock exchanges and are generally considered to be the best investment option for most investors because they offer diversification and low-costs. ETFs are a type of fund that invest in a basket of stocks, bonds, or other assets. What are the main benefits of investing in mutual funds? Mutual funds are investment funds that pool money from many investors and then invest in a wide variety of stocks, bonds, or other assets. Mutual funds are considered to be the best investment option for most investors because they offer diversification and low-costs.
What are the pros and cons of investing in ETFs?
Pros ETFs are very easy to buy and sell. ETFs offer diversification. ETFs offer low fees. ETFs are easy to understand. ETFs are liquid. ETFs are easy to trade. ETFs are easy to trade on margin. ETFs are easy