ETFs (Exchange Traded Funds) – Advantages and Disadvantages
ETFs or Exchange Traded Funds started in late 1980s and has become popular as the investors began searching for another alternative for mutual funds. Investors, both individual and institutional, could see the advantage of holding a particular group of stocks with a lower management fee and high intraday price visibility. On contrary, with the fund’s lower management, the burden was actually places on the investor to choose the right investment. Determining the perks and disadvantages of ETFs will facilitate current and new holders navigate rewards and risks.
There are many advantages of ETFs and these are some of them:
- Lower Fees Than Managed Funds
ETFs, which are managed passively, have lower expense rations when compared to some managed funds. The expense ratio of a mutual fund is basically higher because of the costs including shareholder accounting expenses, service fees, paying board of directors, management fee, as well as load fees for distribution and sale.
An ETF may provide an exposure to the group of equities, styles or market segments. When compared to stocks, ETFs may track a range of stocks and attempt to mimic the country’s returns.
- Lower Premium or Discount in Price
There’s a lower chance to have ETF prices that are lower or higher than the actual value. The ETF’s trade in the entire day at a price is close to the price of the securities. Therefore, if the price is higher and lower than the net asset value, the arbitrage will bring the price back in the line. It is basically different compared to the closed-ended index funds for the reason that ETFs trade is based on the demand and supply and the market makers will capture the price discrepancy profits.
- Dividends Are Immediately Reinvested
The company’s dividends in open-ended ETFs are immediately reinvested, yet the timing may vary for the index mutual funds. This must be noted that the dividends in the unit investment trust ETF isn’t reinvested automatically, which creates a dividend drag.
- It May Be Limited to Bigger Companies
In several countries, investors could be limited to big-cap stocks because of a narrow group of stocks in the market index.
- Bid-Ask Spread a Bit Big
Since most ETFs are made, you might find an investment in low volume index. This might result to a high bid-ask spread. You could also find a better price investing in actual stocks or even a managed fund.
- Intraday Pricing Could Be Overkill
The long term investors might have a time horizon of 10-15 years, so they might not benefit from the changes on intraday pricing. Several investors could trade more because of such lagged swings in hourly price.
ETFs are basically used by different investors to establish a portfolio and gain exposure to particular sectors. These have numerous advantages when compared to some managed funds like mutual funds. However, the tax implications that are often associated with ETFs have to be considered when deciding if the ETFs are best for you.