What are the Disadvantages of ETFs?
In general, the advantages of ETFs compared to mutual funds are that they are significantly lower in cost and much greater in transparency. And, of course, ETFs, like Index mutual funds, provide broadly diversified exposure to an asset class without the problem of style drift that mutual funds incur.
So what are the disadvantages of ETFs? The disadvantages, when it comes down to it, boil down to how investors use ETFs. For example,there are 1400 ETFs from which to choose. How do you know you are choosing the right ones?
Below are some of the characteristics of ETFs that trap investors, and therefore can be viewed as “disadvantages.”
Niche ETFs – Many ETFs are sliced so thin, there is not real diversification. For example, there is an ETF that tracks Peruvian mining stocks in which three companies account for 45% of the funds holdings. There is also an ETF that tracks smartphone suppliers and another that tracks hard drive makers. This type of market segmenting attracts short-term speculators who are looking to make a quick profit by trading or selling short. Furthermore, many of these niche ETFs have less than $10 million in assets, which is not enough for the fund company to earn a profit.If the fund company cannot earn a profit, they may need to close the fund, causing you a headache.
Leveraged ETFs - These ETFs sound good in theory, but are terrible in practice. Due to the nature of volatility, these 2x and 3x bull and bear ETFs never accomplish what the investors thinks it will accomplish. These ETFs are intended to track DAILY price changes, not long-term trends. Inevitably, these bull and bear ETFs attract greed and fear.
ETFs with few assets - If you’re choosing an ETF, make sure it has plenty of liquidity. i.e. You want to make sure you can easily get in and out of the fund at a fair market price.
Momentary pricing – Remember the “flash crash” on May 6, 2010? Active traders who chose to sell their ETFs during the DJIA’s 1000 point decline caused a permanent loss. This would have been impossible for mutual fund investors because mutual funds price once a day. So in this sense, momentary pricing is a disadvantage.
Advertisement
