Exchange-Traded Funds: Pros & Cons

The acronym ETF may be unfamiliar to most but it is important to know for any investor new or old. It stands for exchange-traded fund and it has shown much promise in the investing world. The concept of ETF began officially in 1989 but was taken off the market due to lawsuits. ETFs later popped up again in 1993 making it relatively a new type of investment on Wall Street. Back in 2013 the ETF industry was estimated to hold $1.34 trillion in assets! PwC survey released in 2016 that they see the market tripling in the next five years!

That’s a lot of money and promising projections for an investment that is only 23 years old.

ETF Explained

The concept of ETF is complicated on paper but simple in nature. It is technically an investment fund but operates and is sold like a stock. It holds assets in commodities such as stocks, bonds, indexes and other commodities. It is often compared to index funds and mutual funds but offer distinct advantages to stockowners.

One of my favorite finance resource sites explains an ETF for my visual learners:

 

Before you join the stampeded to buy ETFs, here are the pros and cons.


Pros

Flexibility

I find the flexibility of ETFS to be most attractive for my investment strategy. The stocks are diverse in the sense it can meet my interests and are liquid (depending on the sector). ETFs can also be traded globally and not contained in America, which can be ideal for travelers.

Less Expensive

For starters an ETF offers lower annual fees compared to most mutual fund. Another major reason why ETFs are less expensive is they are passive in nature, meaning they don’t need much management/advisor attention. The stocks will track a stock or bond index and that helps keep cost down. In addition, ETFs don’t have large buy in rates since an investor only needs the price of a stock to be an active investor. Other investment vehicles may require a large deposit to own a piece.

Day Trading

Unlike mutual funds the ETF is a passive stock meaning the prices will vary throughout the day. Day traders find it extremely beneficial, as they are most likely to trade throughout the day. For investors this point may be irrelevant.

Wide Variety

Depending on what interest you most there is a good chance an ETF is out there for you. To name just a few sectors you have options of agriculture, energy, technology, real estate, banks, healthcare, automotive, broad, gaming, crops, utilities and materials. Picking a sector that has your interest is beneficial if you plan on keeping up with the market news and your stock on a daily or weekly basis.

Cons

Brokerage Fees 

Any time you buy or sell an ETF you are exposed to pay a brokerage commission. If you plan on trading more often then not you want to factor the commission rates into your profit planning. For long-term investors this will not be a major concern.

Low Trading Volumes

For certain ETFs it can be hard to match a buyer and seller. This can unfortunately result in owning a stock that you can’t get out of your portfolio. The type of example where s**t can hit the fan is the ETF shows signs of decreasing significantly in value and all sellers are trying to unload the stock at the same time.

Risk

Considering the three investment vehicles (stocks, mutual funds, bonds) this will present the most risk. Stock prices go up and down daily. Though we have been in a bull market the past seven years the market could transition into a bear market and bring down the value of ETF stocks in certain sectors. The decrease of value will be the ending result, unless a seller is able to unload the stock.


Bottom Line is that ETFs tend to have more pros than cons, especially if you are comparing them to mutual funds. I personally believe they should be part of a portfolio and can be considered risky, as they are stocks. However, if you are young and can bounce back I deem the risk worthy. Check with your finance professional before buying a large number to make sure it intertwines with your investment strategy and goals.

 

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