With the growing popularity of ETFs worldwide, many investors have started to include these products in their portfolios. While ETFs can be a great investment choice, there are a few things that investors should be aware of before investing in them. We will discuss six concerns investors should be aware of when investing in ETFs.
What are ETFs?
It is a type of fund that invests in a basket of assets, including stocks, bonds, commodities, or even other ETFs. ETFs are popular because they offer investors a simple and cost-effective way to access a wide range of markets; click for more info. For example, an investor who wants to invest in the US stock market can buy an ETF that tracks the S&P 500 index.
What concerns should investors be aware of when investing in ETFs?
Lack of liquidity-
One of the main concerns about investing in ETFs is the lack of liquidity. It can be challenging to sell your ETF units when you want to cash out, and it is because there is usually only a small number of buyers in the market for ETFs. It can lead to large bid-ask spreads, meaning you may have to sell your units at a lower price than what you paid.
Another concern investors should be aware of is counterparty risk. It is the risk that the other party in a financial transaction will not be able to fulfill their obligations. For example, if you are investing in an ETF that tracks a basket of bonds, the counterparty risk would be the risk of the issuer defaulting on their payments.
Tracking error is another risk that investors must be aware of when investing in ETFs. It is the difference between the performance of the ETF and the performance of the underlying assets it tracks. For example, if an ETF tracks the S&P 500 index, but only gains 5% while the index gains 10%, then there is a tracking error of 5%.
Another concern investors should be aware of is that ETFs have a little history. It means that there is not a lot of data available to assess how they have performed in different market conditions.
Regulatory risk is another risk that investors need to be aware of when investing in ETFs. It is a risk that government regulation changes could adversely impact ETFs’ performance. For example, if the government decided to ban leverage in ETFs, this could harm the performance of leveraged ETFs.
Exchange-traded notes (ETNs) are another type of investment that investors should be aware of. ETNs are similar to ETFs but unsecured debt instruments that banks issue. It means that there is credit risk involved with investing in ETNs. Investors should also be aware that any assets do not back ETNs, so if the issuer defaults on their payments, they could lose all of their investment.
The benefits of investing in ETFs
Despite the concerns investors should be aware of, there are also many benefits to investing in ETFs.
One of the main benefits of investing in ETFs is that they are cost-effective, and this is because they have low fees and expenses. For example, the expense ratio for the SPDR S&P 500 ETF (SPY) is 0.09%.
Another benefit of investing in ETFs is that they offer diversification, which means they can help protect your portfolio from the risks of investing in just one asset class. For example, an investor investing in an ETF that tracks the S&P 500 index will be diversified across 500 stocks.
Another benefit of investing in ETFs is that they are liquid, which means buying and selling units on the stock market is easy. ETFs are also traded on margin, so investors can use leverage to magnify their returns.
Despite the concerns investors should be aware of, there are also many benefits to investing in ETFs. These include the fact that they are cost-effective, offer diversification, and are liquid.