What are the disadvantages of ETF?

ETFs Risks: The Downsides of Investing in ETFs

Reading time: 10 Minutes

ETFs, or Exchange-Traded Funds, represent a basket of stocks, commodities, and more.

An ETF—a collection of securities—can be bought or sold through a brokerage firm on a stock exchange, similar to common stocks. As a result, investor purchases and sales of ETF shares can affect the price of the ETF.

ETFs often follow a certain sector, index, commodity, or asset. However, an ETF has the ability to follow the price of anything from a single commodity to, as noted above, a large and diverse group of assets.

Disadvantages of ETF Trading

  • Trading Fees.

ETFs aren't free, despite having lower management fees than mutual funds. As ETFs are traded like stocks, investors can pay 8 USD to 30 USD each time they buy or sell fund shares. These costs can compound and impair your ETF performance if an investor buys modest amounts of shares frequently.

Some ETFs can have no trading commissions, though this depends on the brokerage.

  • Trading Volume.

An ETF's trading volume can be influenced by its liquidity.

ETFs that invest in S&P 500 companies, for example, stocks that work with high trading volume with a large number of willing buyers and sellers, operate with higher liquidity. Low-volume ETFs often invest in small-cap firms that are less liquid; they are traded less frequently.

Ultimately, ETF investors seek ETF stocks with high trading volume and liquidity. This lessens liquidity risk.

  • Dividends.

While some ETFs provide dividends, investors may find other investments that boast substantially higher yields to increase overall portfolio return. This is partially because ETFs offer a wider market and, as a result, typically offer provide yields. Of course, an investor willing to assume the increased risk of owning a particular stock may, therefore, benefit from increased dividends.

  • Capital Gains.

ETFs that pay dividends generate income. When ETFs profit: when investors sell assets, it results in capital gains for that investor.

Reinvesting returns requires purchasing additional ETF shares, which can result in more fees.

  • Ethical Investors.

Ethical investors may choose not to invest their money in companies that sell cigarettes or meat goods, for example. Consequently, using ETFs to fulfill certain investment requirements and objectives can be challenging when the ETF tracks companies you don’t like.

What are the Risks of ETFs?

  • Tax Risk.

Most investments are subject to capital gains taxes. Put simply, if you buy a security, such as a stock, and sell it for more than you bought it, it will be liable for tax. Ultimately, it is your responsibility to know your tax obligations. Research your selected ETFs and any tax liabilities involved.

  • Liquidated ETFs.

Each year, about 100 ETFs are shut down. Following the liquidation of the fund, shareholders of those ETFs will be compensated.

  • Tracking Errors.

Although rare tracking errors occur, fund managers try to keep their investment performance aligned with the index it tracks. One reason can be when the fund manager makes investment decisions: swapping asset classes; this can cause tracking errors, as the ETF may deviate from the index's performance.

  • Counterparty Risk.

Counterparty risk refers to the possibility that the other party in an investment, credit, or trading transaction, won't carry out its end of the agreement and break the contract terms. Investors in ETFs are thus subject to counterparty risk: the possibility of suffering a loss due to the counterparty's breach of contract.

How Much Should I Invest in ETFs?

Most individual investors recommend 5-10 ETFs. Investors don't normally invest more than 30% of their portfolio.  Sector ETFs are in place if you'd prefer to focus on specific sectors; you may, therefore, use sector ETFs for your exchange-traded fund investment objectives.

Industry ETFs, on the other hand, invest in equities of particular industrial sectors, such as the energy, biotechnology, or chemical industries. Most people invest in US equities, but ETF suppliers are increasingly introducing goods that simulate performance in several worldwide industrial sectors.

What is the Safest ETF to Buy?

With inflation rising and recession looming, as the worldwide economy struggles with rising energy and food prices, investors are looking for safer investments. Below are three considered safe investments, but as with any investment, nothing is guaranteed.

  1. Gold - SPDR Gold Trust ETF (GLD).

In times of political or economic unrest, gold is seen as a place of refuge. The appeal of bullion as a store of value has increased due to worries about the global economic downturn.

  1. Dividend - Vanguard Dividend Appreciation ETF (VIG).

These stocks provide an ideal combination for many investors: security in the form of dividends and stability in the form of established companies that are less sensitive to significant fluctuations in stock price.

  1. AGFiQ US Market Neutral Anti-Beta Fund (BTAL).

The $175.4 million Market Neutral Anti-Beta Fund has an expense ratio of 2.53% and an AUM of $175 million. It trades 196,000 shares every day on average.

Are ETFs Good for Beginners

To acquire exposure to stock market indices, novice investors may consider purchasing an ETF. Broad exposure to main markets such as the S&P 500 or FTSE All Share is considered a sensible core part of any beginner investor's portfolio.

ETFs are good for both novices and seasoned investors. They're generally less hazardous than buying individual equities, accessible through Robo-advisors and conventional brokerages, and affordable. This is largely because of its numerous advantages, including low expense ratios, high liquidity, a wide variety of investment options, diversification, a low investment barrier, and more.



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