ETF’s: Pros and Cons Exchange traded funds (ETF) are often compared to mutual funds, in that they invest in a wide variety of shares. There are some important differences which will govern what type of fund is good for you and your investment objectives. The advantages that are often cited for ETF’s include †* Liquidity. It is easy to buy and sell ETF’s as they are traded on the markets all day long. You can even place limit and stoploss orders just as with shares, and so they are suitable for the short-term trader. * No minimum investment. Unlike mutual funds, you can buy ETF’s one share at a time, and there is no minimum holding. * Many ETF’s are set up to track an index, which means that they generally have lower management expenses than mutual funds. * ETFs have tax advantages over mutual funds as they are taxed like shares, and you pay capital gains tax only when you sell. ETF’s also have some advantages over trading stocks, and are frequently used for swing trading. * Compared to shares, ETF’s allow you to easily invest with full market diversification. * Because ETF’s are traded like shares, it is also possible to buy options on them. This allows the trader to use puts and calls, for example, and gives scope for greater profit. All these advantages make ETF’s an alternative financial instrument for trading or investing long-term, and although much more recently introduced to the marketplace than mutual funds they are proving to be extremely popular. However there are aspects of them which can be considered disadvantages †* Every time you trade an ETF, you need to pay a broker commission. While some mutual funds have upfront fees, generally they are bought without fees. * For the investor, the way ETFs are bought requires them to open a brokerage account, which would not be necessary to invest in other funds. * Because ETF’s are traded like stocks, there is a bid price and an ask price, which creates â€slippageâ€, or losses if you trade frequently. A mutual fund has a net asset value (NAV) which is fully based on the value of the underlying holdings. * An ETF may not fully reflect an index in its price. This is because the price will vary according to market supply and demand, so even if the ETF’s holdings are exactly those of the index its price may not be. It won’t be very different, however, because of the arbitrage opportunities this presents. * For the long-term investor, mutual funds offer automatic dividend reinvestment, a feature which is not available with the ETF. * For the regular investor, the commissions on ETF purchases can mount up. For instance, it is efficient and economical to invest a certain amount each month in a mutual fund. Adopting the same strategy with ETF’s would offset the returns because of the cumulative fees. The use of ETF’s is expanding, and, as they can be actively traded easily, unlike mutual funds, they are finding a place in many traders’ portfolios. They are a multi-purposed financial instrument that many people are finding useful in their financial dealings.
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