ETFs: Pros And Cons

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Investing in the stock market is one of the many common methods of wealth creation that is known to bring great returns in the long run. Visit مجموعة ملتي بانك

A key factor which makes the stock market a popular choice is the number of financial products it allows access to. One such product is a mutual fund. 

A mutual fund refers to a collection of securities that are managed by an expert finance professional. These funds have various categories and typically suit people with varying risk appetites.

What is an Exchange Traded Fund (ETF)?

An exchange-traded fund refers to a basket of securities which generally tracks a stock market index’s movements. Contrary to various other mutual funds, ETF units can be bought or sold on the stock market the way company shares are.

Though a majority of mutual funds are structured in a way that they outperform a certain yardstick, ETFs are essentially aimed at tracking an underlying factor.

The fund manager typically invests in the stocks that are part of the market index in order to replicate its performance.

Probably drawing a parallel between mutual funds, index funds, and ETFs may bring some clarity on how these investments operate:

Mutual Funds:

Mutual funds help in investing in a portfolio of various investments — generally stocks, but a fund may also have bonds along with different types of securities.

Generally, mutual funds are taken care of by an expert professional advisor who is able to buy and sell investments to ensure that you get great returns for the money you’ve invested. 

A majority of mutual funds come with a fee which is typically around 1% of the overall assets that you invest over a year. This is in general said to be payment for operating costs in addition to being a premium for the fund advisor’s knowledge and experience. 

Index Funds:

An index fund is also a type of mutual fund which is created to replicate the increase and decrease in the overall market index. An index fund usually takes a buy-and-hold approach rather than trading often. The truth is, such index funds have many times performed better than a mutual fund which is steered by an expert despite having much lower annual fee. 

Index funds are weighted by market capitalization. Larger companies account for a higher proportion than smaller companies.

ETFs:

ETFs tend to be similar to index funds as they allow you to invest in an already formed group of investments which is in most cases an index. The way an ETF and an index fund is traded is what differentiates the two. You could buy an ETF the way you’d buy a stock and yet the price of ETFs may be very low.

Here are some advantages of ETFs:

Pros of ETFs

Diversification

A major aim of any reliable and good asset allocation strategy is diversification. It allows you to invest in different asset classes as well as a range of companies in every asset class.

ETFs could even be the best of the lot when it comes to diversification that allows you to gain more exposure to a predetermined asset group. 

Transparency

In the case of a majority of ETFs, investors are able to monitor the movement of the underlying portfolio on a daily basis. Mutual funds on the other hand have to report their holdings a few times in a year.

Trade Like Stocks

Similar to individual shares of stock, ETFs could be easily bought and sold when the stock exchange is open. Mutual fund orders have to be submitted prior to the market’s closing along with the purchase or sale which may take place after the market closes for the day. 

Though there are clear disadvantages to day-trading and market timing, it is still a good thing to be able to enter or exit an ETF as per your requirement. It even implies that market orders like stop orders, limit orders, among others could be placed on an ETF to be able to begin a trade when it reaches a particular level (up or down). It works in a similar way like shares of individual stocks in the sense that ETFs may even be sold short or one could speculate and bid on a fall in its price. You could purchase or sell options against ETFs, irrespective of whether it’s a good move or not. 

Cheap to Own

Several ETFs are cost effective. This helps in making low-cost ETFs a wise pick for long-term investors as well as for the ones looking to invest for retirement. Fees and expenses play an important role in ensuring the success of your long-term investments therefore, having low-cost ETFs could be useful. 

Low investment

Mutual funds (even index funds) generally come with a minimum buy-in investment. For the ones who are just getting started or would not prefer to invest in the typically high minimum—well you’re not likely to be so lucky. 

Cons of an ETF

Be Aware of What You Are Buying

Now that there are many types of ETFs around, it becomes important to fully comprehend what you’re getting into.

Certain ETFs can be relatively easy to understand. Other ETFs may have unusual investment objectives or use complex investment strategies that may be more difficult to understand and fit into an investor’s investment portfolio. For example, “leveraged ETFs” seek to achieve performance equal to a multiple of an index after fees and expenses. These ETFs seek to achieve their investment objective on a daily basis only, potentially making them unsuitable for long-term investors.

Bid-Ask Spreads

Without bothering about the technical details, bid-ask spreads take place when a seller agrees to give up their goods for a sum which is lower than what a buyer maybe open to paying. 

This happens with stocks that are traded on an exchange and also with ETFs. But given that mutual funds can be settled once daily, the bid-ask spreads are not as bold as with mutual funds. Know more تحميل ميتاتريدر 4

Intra-day Peaks

While this may happen with stocks as well as when you purchase an ETF when the timing is not right and its value goes up. Alternatively, when you sell an ETF, the timing may not work in your favour and you might end up selling when the prices fall. Though you could take steps to bring down the risks, mutual funds are settled once daily and are not affected by intra-day peaks.

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