Photo of Ray Ferrara CFP Ray Ferrara CFP Oct 16, 2020

For years, investors have used mutual funds to diversify their portfolio and build their portfolio by one security at a time. Then, in 1993, exchange-traded funds (ETFs) were introduced. Basically, they took the benefits of mutual funds to the next level in some cases.

An ETF is a type of security that includes a collection of securities that tracks an underlying index. ETFs can also be used to invest in a wide variety of industry sectors. ETFs are similar to mutual funds, but one key difference is that they are listed on exchanges and are traded throughout the day like ordinary stocks as opposed to mutual funds, which can only be bought and sold at the end of the trading day.

ETFs have exploded in popularity since their introduction, but this does not mean they are always right for you. Before deciding on whether to invest in ETFs as an opportunity for growing your wealth and diversifying your portfolio, you should get to know their benefits and disadvantages.

Four ETF benefits

  1. Diversification — A single ETF can give an investor exposure to a group of entities and market segments.
  2. Flexibility — ETFs are traded like a stock, which gives investors the opportunity to purchase on margin and sell short, although only very sophisticated investors should do so. ETF prices are updated throughout the day like stocks, rather than being priced at the end of the day like a mutual fund.
  3. Low fees — ETFs are passively managed so they have lower expense ratios compared to actively managed mutual funds or other actively managed investments.
  4. Limited capital gains tax — Because ETFs are passively managed, they tend to generate fewer internal capital gains than actively managed investments. Reducing capital gains year over year helps to lower your tax liability for the sale. You may still pay a capital gains tax when you sell an ETF with a gain.

Three ETF cons

As good as ETFs sound, no investment is perfect. Here are some disadvantages of ETFs to consider before investing:

  1. Limited diversity — Some ETFs, such as those tracking foreign stocks or a small segment of a market, may be limited to a more narrow group of investments than in the market index. This limited exposure can leave you missing out on potential growth opportunities.
  2. Increased risk — As with any investment, the more risk you put into an ETF, the more potential you have for generating a higher return. However, although ETFs have diversification, they may not be as well diversified as a mutual fund.
  1. Cost — While an ETF can be more cost efficient than a mutual fund because it is passively managed, it may not be as cost efficient as individual securities. When investing in specific stocks, you still pay a commission fee but there is no ongoing management fee on it; but there are management fees for ETFs.

Talk to a ProVise CFP® professional about getting the most out of your investments

In short, when it comes to investing, it is best not to put all your eggs in one basket. You should diversify your portfolio by investing in a variety of interests, including stocks, bonds, ETFs and mutual funds. The real trick is in deciding how much to invest in which areas and for how long.

Making investment decisions on your own can be like walking through the night without any light to guide you. A financial advisor can act as your light to help you see where you are going and reach your financial goals.

At ProVise Management Group, our CERTIFIED FINANCIAL PLANNER™ professionals can get to know you and your current financial circumstances, goals, risk tolerance and personal values to help you develop a financial plan that works for you. We can also create a written plan for you at a fiduciary standard of care. All our written plans come with an unconditional money-back guarantee. If you are unhappy with your written plan, you can return it to us, and we will refund 100% of the fee paid.

Are you ready to talk to a professional about managing your investments and finances? Contact ProVise today to schedule a complimentary consultation.