Exchange-traded funds or ETFs are a type of investment fund. They track an index (such as a bond index or stock index), a commodity (such as gold and other precious metals), or a basket of assets. Unlike mutual funds, they can be traded on a stock exchange, and they can bought and sold at any time of the day.
Just like any other investment vehicle, exchange-traded funds have their own benefits and drawbacks. So, before you invest in them, you need to know what these pros and cons are and decide if ETFs are the right option for you.
List of Pros of ETFs
1. They don’t have a minimum requirement.
Most echange-traded funds don’t have a minimum deposit requirement, so you can purchase even just one share. This is great if you would like to start investing but don’t have much money. This is also a good idea if you want to branch out into new investment vehicles but want to test the waters before putting in a large amount of money.
2. They promote diversification of investments.
ETFs allow you to have a small slice of the securities in the basket, so you can diversify your investment by taking small, simple steps. It’s a great way to strengthen your nest egg and reduce the risk of losing all your money.
3.They are tax-efficient.
As their name implies, exchange-traded funds transactions happen on an exchange, between people who own ETFs and who want to buy them. This means that no actual sale takes place in the ETF package and that neither the sellers nor the buyers have to pay capital gains tax.
4. They are more liquid than other investments.
ETFs can be sold throughout the day. This can be an advantage if you’re a day trader who’s looking to earn money quickly or just someone who needs to have access to cash at any time for emergencies.
List of Cons of ETFs
1. They can lead to higher trading costs.
While exchange-traded funds are considered to have low expense rations, some financial experts have pointed out that they can still be pricey. This comes from the fact that they’re short-term speculations, which means they usually involve many trading costs including commissions. These can significantly reduce the investors’ ROI.
2. They are volatile.
Some experts argue that ETFs have reduced volatility because they group a number of stocks, which are less likely to decline in value compared to a solitary stock that can experience problems due to an eroding bottom line or internal management issues. But there are also those who point out that exchange-traded funds are more volatile since they are closely connected to stock markets. If stock markets experience bizarre trading patterns, this can significantly affect ETFs.
3. They can present higher risk.
Several ETFs use leveraging, which means they owe their high gains to borrowed money and not to good performance. Others, meanwhile, hold bonds that have poor quality and are in themselves a huge risk. Some experts point out that the inherent structure of exchange-traded funds causes them to exaggerate losses, which can be damaging for investors who aren’t fully aware of what they’re investing in. Because of these, it’s important for investors to fully understand ETFs before plunking down their money and ask how the funds are traded.
Consider these pros and cons first before investing exchange-traded funds to ensure you’re making the right decision.
Brandon Miller has a B.A. from the University of Texas at Austin. He is a seasoned writer who has written over one hundred articles, which have been read by over 500,000 people. If you have any comments or concerns about this blog post, then please contact the Green Garage team here.