Why Invest in ETFs?

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  • Diversification

    One ETF can give exposure to a group of equities, market segments, or styles. An ETF can track a broader range of stocks, or even attempt to mimic the returns of a country or a group of countries.

  • Trades Like a Stock

    Although the ETF might give the holder the benefits of diversification, it has the trading liquidity of equity. Because ETFs trade like a stock, you can quickly look up the approximate daily price change using its ticker symbol and compare it to its indexed sector or commodity.

  • Lower Fees

    ETFs have much lower expense ratios compared to actively managed funds.

  • Immediately Reinvested Dividends

    The dividends of the companies in an open-ended ETF are reinvested immediately. One exception: Dividends in unit investment trust ETFs are not automatically reinvested, thus creating a dividend drag.)

  • Limited Capital Gains Tax

    ETFs can be more tax-efficient than mutual funds. As passively managed portfolios, ETFs (and index funds) tend to realize fewer capital gains than actively managed mutual funds.

  • Lower Discount or Premium in Price

    There is a lower chance of ETF share prices being higher or lower than their actual value. ETFs trade throughout the day at a price close to the price of the underlying securities, so if the price is significantly higher or lower than the net asset value, arbitrage will bring the price back in line. Unlike closed-end index funds, ETFs trade based on supply and demand and market makers will capture price discrepancy profits.

 While the pros are many, ETFs carry drawbacks too. Among them:

  • Less Diversification

    For some sectors or foreign stocks, investors might be limited to large-cap stocks due to a narrow group of equities in the market index. A lack of exposure to mid- and small-cap companies could leave potential growth opportunities out of the reach of ETF investors.

  • Intraday Pricing Might Be Overkill

    Longer-term investors could have a time horizon of 10 to 15 years, so they may not benefit from the intraday pricing changes. Some investors may trade more due to these lagged swings in hourly price. A high swing over a couple hours could induce a trade where pricing at the end of the day could keep irrational fears from distorting an investment objective.

  • Costs Could Be Higher

    Most people compare trading ETFs with trading other funds, but if you compare ETFs to investing in a specific stock, then the costs are higher. The actual commission paid to the broker might be the same, but there is no management fee for a stock. Also, as more niche ETFs are created, they are more likely to follow a low-volume index. You might find a better price investing in the actual stocks.

  • Lower Dividend Yields

    There are dividend-paying ETFs, but the yields may not be as high as owning a high-yielding stock or group of stocks. The risks associated with owning ETFs are usually lower, but if an investor can take on the risk, then the dividend yields of stocks can be much higher. While you can pick the stock with the highest dividend yield, ETFs track a broader market, so the overall yield will average out to be lower.