The Risks and Benefits of ETF Investments

Using ETF investments has become a very popular way to invest in the last few years. The ETF has only been around since 1993 in the United States. Therefore, there are still a lot of people that do not know the first thing about them. The ETF presents investors with several advantages that they can not get anywhere else. With that being said, they also have their drawbacks as well. Here are a few risks and benefits that are commonly associated with ETF investments.

Benefits

  • Flexibility- The ETF is one of the most flexible types of investments available. In this regard, they are most similar to stocks as they can be bought and sold on a stock exchange. A mutual fund is similar but can only be traded at the end of the trading day. This gives ETFs a clear advantage to those that like to frequently trade.
  • Lower costs- While this might not always be the case, ETFs generally have lower costs associated with them than comparable mutual funds. They are not managed as actively as mutual funds and have lower transaction costs as a result. You also do not have to pay 12b-1 fees like you do with other similar investments.
  • Tax efficiency- With ETFs, you do not have to worry about taxes like you do with some other investments. They very rarely have capital gains because they traditionally employ the buy and hold method with stocks. Those that run the ETFs are authorized participants which allows them to manipulate the fund so that capital gains are not triggered. By comparison, you could have to pay mutual fund capital gains taxes based on how many people decide to buy and  sell their shares.
  • Transparent pricing- With mutual funds, you sometimes do not fully know what you are investing in. Some fund managers prefer to not disclose everything in real time. With ETFs, you can know everything immediately. They are valued every 15 seconds, so you can get a real-time quote on them immediately.
  • Track indexes- Another common feature of ETFs is that they track popular indexes. For example, one of the most popular forms of ETF tracks the S & P 500 index. This tends to give the ETF a steady performance and growth curve over the years.
  • Invest in industries- For the longest time, about the only way to invest in certain industries was through futures contracts. For example, you could not get involved in the oil industry unless you took out a complicated oil futures contract. This was not possible for most people. Now you can buy an oil ETF.

Risks

  • Market risk- When the market declines, so will the performance of most ETFs. This is not a foolproof method of investing.
  • Low growth potential- While they are similar to stocks as far as flexibility is concerned, they do not typically perform like stocks can. This is usually a very long-term investment.
  • Bad management- When you invest in an ETF, you are investing with a particular management company to handle the stocks that go into the fund. Relying on others can sometimes lead to mistakes. 
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