When looking into investing, you may come across something called an ETF. But what are ETFs exactly, and how beneficial could they be?
Exchange Traded Funds, or ETFs, are investments funds that trade on an exchange just like stock. In a way, ETFs work like mutual funds but mutual funds trade only at the close of a market day.
With ETFs, they take mutual funds a step further; these shares can be bought and sold throughout the trading day. Additionally, ETFs give you a way to buy and sell a basket of assets without having to buy every component individually.
Financial expert Suze Orman even said that anyone who “makes investments outside of any retirement accounts are absolutely crazy if you are using actively managed funds rather than ETFs.” So how good are they?
While shopping for ETFs, it’s important to consider the pros and cons of them before deciding to buy and invest in them.
Pro – Tax Benefits
One pro about investing in ETFs involves tax benefits. Although these and mutual funds work in a similar fashion, the two do have structural differences.
With mutual funds, you’ll get taxed throughout the course of the investment. However for investors with ETF’s, they only get taxed after they sell their investment and also have lower capital gains tax.
Con – Looking for ETF Buyers
A potential con comes with looking for people to trade ETFs with. After investing and when the time comes to try and sell or trade your ETFs, you may be ready to do so, but if your ETFs haven’t been traded as frequently, it may be harder to unload.
Pro – Diversification
Another positive aspect of having these funds comes with portfolio diversification. Sometimes, investors may want to gain exposure in industries or markets that they don’t have a lot of expertise in, and it could cost a pretty penny to buy the components you need individually; ETFs help grant you you easy exposure to the specific desired market segment you want.
Con – Trading Costs
The cost of trading an ETF depends on where you trade; not only that, but those costs may not end with the expense ratio—or how much the ETF would initially cost. Since these funds are Exchange Traded funds, it’s possible that you may need to pay a commision fee to online brokers.
Pro – Transparency and Flexibility
Anyone has the ability to search for the price activity of an ETF online. At the end of every trading day, the public can also view the holdings in each fund; with mutual funds, fund holding can only be viewed by the public every month or every quarter.
Additionally, since ETFs are traded throughout the day, this allows for investors to make timely investment decisions during that period.
Con – The ETF Might Close
There’s a possibility that an ETF that you invest in could close at any given time. This usually happens when the fund doesn’t have enough assets to cover administrative costs. Because of this, it may cause investors to have to reinvest their money with the chance of receiving a tax burden, or that investors will need to sell sooner than they would like to.
These are only a few pros and cons to whether or not one should look into investing in Exchange Traded Funds, but ultimately it’s up to the investor and what they’re looking for.
To learn more about ETFs and the different type out there, check out Fidelity Investments.
