Exploring the ETF pros and cons every investor should know
Exchange-traded funds (ETFs) are an important part of many investors’ portfolios because of the many advantages they have to offer. An ETF is similar to a mutual fund, except it can be bought and sold throughout the day on stock exchanges.
ETFs combine the features of index funds and individual stocks and represent many different areas of interests, such as specific stock indexes and different industry or business sectors. This makes them attractive to investors who believe in the growth of a particular index, business type, or industry but do not want to invest in one or two specific companies.
Pros of ETFs
- Liquidity — Since ETFs are traded on stock markets, they are highly liquidable, which means they can be bought and sold with relatively little difficulty.
- Low volatility — Because ETFs embody a specific sector rather than one specific company, they are less vulnerable to volatility. For example, if you believe the electric vehicle (EV) sector will grow soon, rather than investing in one EV company, you can invest in an EV-specific ETF. This way, if one company does poorly but the others in the ETF do well, you are still earning gains.
- Diversity — As of 2020, there are more than 7,000 ETFs globally. They are available in virtually every sector and business type in which one may be interested in investing.
- Tax efficiency — ETFs are usually more tax efficient than mutual funds. They are passively managed, so they tend to realize fewer capital gains than mutual funds.
Additionally, there are no actual sales of securities when buying or selling an ETF. They are bought and sold like stocks, which helps reduce your capital gains tax liability compared to selling securities.
- Reinvested dividends — The dividends of companies in most ETFs are reinvested immediately, unlike mutual funds, which have varying exact timings of dividend reinvestment.
Cons of ETFs
- Restricted diversification — While there is a broad range of ETFs in various sectors, investing in ETFs alone does not provide enough diversification. Holding on to an ETF can produce long-term profits, but they are not typically as beneficial for short-term investing.
- Commissions — Commissions and other trading costs associated with ETFs could erode investor returns, further limiting their benefits for short-term traders.
- Lower dividends than stocks — Many ETFs pay dividends, but the yields may not be as high as those of individual stocks. There are usually fewer risks with owning ETFs, but with high risk comes high reward; owning dividend-yielding stocks is riskier but also may pay out more.
Talk to a ProVise CFP® professional about ETF pros and cons
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 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 ETF pros and cons? Contact ProVise today to schedule a complimentary consultation.