Benefits Of ETFs :

Benefits of ETFs outweighs their negative points. For this reason the size of an ETF industry around the world has grown to over $3 trillion and is still growing. From such a huge size we can say that the ETFs(or Exchange Traded Funds) are becoming increasingly popular investment products.

There is no doubt that there are some reasons behind that. ETF comes with the bunch of benefits compared to other investment products. Here we will just take a look at some of the ETFs benefits.

Advantages Of ETFs

Disadvantages Of ETFs

Advantages Of ETFs

Easy to execute trading strategies :

  • No matter what trading strategy you develop, you will find ETFs to execute the strategy with ease.

  • No matter if you want to invest in real estate, corn, oil or an index or just run a market rotation strategy. You will find a broad choice of ETF to help you to execute the trading strategy without the need of doing further research on the trading instruments.

Portfolio Diversification :

  • ETF investing allows investors to invest in the broad market. ETF enable access to many markets that never ever possible before almost every country index, commodity, industry sectors, and bond markets.

  • When you invest in a piece of ETF share it means you are in investing in broad index such as S&P 500 (eg. SPY, IVV, VOO), DAX (eg. XDAX, iShares Core DAX UCITS ETF, iShares MSCI Germany ETF, WisdomTree Germany Hedged Equity ETF), FTSE (eg. FEUZ, FEP, EZU).

  • It means you are not just investing in performance single security you are investing in the performance of the whole index.

  • ETF not only invest in stocks index it also invests in commodities, currencies and bond index hence it is the best way to diversify your investment.

Easy to Trade :

  • This is one of the unique features of Exchange Traded Fund, unlike the mutual funds, ETFs can be traded throughout the day at Exchange just like Stocks. You can simply buy or sell ETF shares through your broker. (Learn about "Difference between Exchange Traded Funds and Mutual Funds")

  • ETF system allows traders to trade ETF share for intraday or short term. It enables speculative investors to trade short-term directions of the market.

  • Stock trading involves concentrated risk but ETF trading remove concentrated risk since its a basket of stocks or any other security hence the risk get diversified.

Cost Efficiency :

  • Cost efficiency is another great feature of ETF Funds which can boost your investment performance.

  • Unlike mutual fund ETFs do not charge exit load fees and other management fees since ETFs are traded on the exchange they subjected to brokerage charges which are variable depending upon brokerage firm but low in cost compared to mutual funds.

  • It has been said that the average management fees of the US Large Cap Mutual Fund are almost three times the average management fees US Large Cap Equity Fund.

  • Also, ETF Expense Ratio is less than the mutual fund, less ETF charges ads more value to your investment.

  • Considering all the aspects ETF investing is more beneficial rather than the mutual fund investing in terms of cost efficiency.

Liquidity :

  • ETF Funds are often praised for its liquidity. It’s a fact that ETF shares are more liquid than Mutual Fund.

  • Generally, the liquidity of stocks is determined by the certain amount of shares which are actively traded on Exchange on daily basis (eg. 110,000 shares). But in case of ETFs, it's little different. In ETF Funds, demand and supply of the shares are flexible. Authorized Participants can "create" or "redeem" the shares depending upon how efficient it is to do so.

  • Most of the ETF Funds are liquid. There is a simple equation the securities which are actively traded are more liquid. Therefore ETF’s which invest in actively traded securities are more liquid than that do not.

Transparency :

  • For an Investor, transparency simply means access to information about fund manager or the companies' stocks and other securities in which fund is investing.

  • Normally mutual funds and other investment funds publish their fund holdings with a time lag. Therefore investor is always unaware of current or updated holdings of funds but ETF Funds publish their holdings on the daily basis which helps the investor to take a quick decision on investment.

  • Also, Exchange traded funds are traded on an exchange throughout the day which allows investors to see ETF daily performance and updated NAV (Net Asset Value), unlike mutual funds who disclose their NAV at the end of the day.

For most investors the benefits of ETF overweight the negative points, but to be fair we have to mention the disadvantages of ETFs too:

Disadvantages of ETFs

Higher Counterpart Risk :

  • Each ETF is a legal entity which pools the money of many different investors. The ETF investor does not own the share or the underlying asset of the ETF direct; he owns it over the ETF Fund legal structure. It can happen that the ETF Company goes bankruptcy or other things can happen to the money of the ETF. As the money is not segregated in the customer's name but pooled under the name of all customers there is not real guarantee that the customer get his money back. Note: Funds are regulated by many laws and it is unlikely that an investor lose money in an ETF investment.

  • The ETF Company might sign complex legal contracts which influence the value the ETF investments without informing the customers. The customer's money might be used as collateral by the Funds Company.

  • The ETF might be forced to use Derivatives to replicate the index. Derivatives or SWAP deals might result in high risk or high losses and increase the cofunterpart risk for the Fund or the whole Legal entity which issues the Funds.

Higher Cost compared to Direct Investment :

  • All ETF have to charge their costs to the ETF holder. The typical published cost (call TCR or Total Cost Ratio) ranges from 0,2% to 1% and even some ETF claim to be cost free. The direct investment in the underlying shares or bonds is always cheaper than to buy the ETF as the investor saves the cost of the ETF management.

  • The ETF might (legally) pay expenses from the amount invested in the ETF and not declare it as "management cost" in the TCR. For example if fund manager visits some of the companies in the ETF the cost might be paid out of the investment sum of the investors and not counted as management costs.

  • The direct investment has to be considered if the investor invests a higher investment amount or the ETF only contains a small number of holding. For example if a bond ETF contains only 5 bonds and the investor plans to invest 100 000 CHF into this ETF it is probably smarter to buy the 5 bonds direct and not over the ETF. The same is true for special ETF like commodity ETF, where the investor is better off to buy the Future direct or other special ETF like inverse or leveraged ETF where Futures are much cheaper.

Less Transparent than a Direct Invest :

  • The legal structure of the ETF Company is hard to understand for an end customer.

  • Investor has to trust that the ETF operates correctly. If he owns the underlying investment direct in his account he can better oversee and track the investment.

  • Some non-UCIT ETF might not be able to declare their holdings in a tax transparent way. Holding non tax transparent ETFs can have negative effects for the investors.

  • If you hold shares over an ETF you will not be able to execute your shareholder rights for the underlying stocks. If you hold a stock direct you get an invitation to participate at the shareholder meeting and you will be able to speak on the meeting or raise your voice and execute your rights as a shareholder. With an ETF the ETF Fund company will execute your shareholder rights. You will not receive takeover or split offers or other information's from the underlying companies.

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