7 things you should be aware of before investing in ETF?

An exchange-traded fund (ETF) has been the hot topic of the last few years. In many ways, its popularity reflects mutual funds in the 1980s and 1990s or index investing in general. But while ETFs have a lot going for them, they are not appropriate for everyone. Here are seven things you need to know before investing in ETFs:

Most ETFs track an index

Many people buying into ETFs think they will get the market return with a lower fee. It is possible when it comes to specialized markets such as frontier markets, but most often, it isn’t [the case]. [In fact], [for example], Vanguard’s S&P 500 tracker charges 25 basis points (0.25%) while Vanguard’s total stock market tracker charges 0.17% and the US small-cap fund charges 0,32%.


That means that any investor can get an index return for a much lower fee than buying into most ETFs.

They are easy to trade but not as tax efficient as index funds

ETFs are traded like stocks, which means they can be bought and sold at any time during the day, and you can even short them if your broker allows it. It makes them very suitable for active traders – something you shouldn’t be if you don’t know what you’re doing – and has implications for investors who ignore the calendar.


Whenever someone sells an ETF, there is a tax implication for whoever ends up holding the ETF.


Since the government knows that people will try to avoid this, it is considered a wash sale if you sell your shares at a loss and then repurchase them 30 days later. If you wait 31 or more days before buying new ones, however, you can claim the difference as capital loss which does help ease the burden of taxes.


On the other hand, this isn’t an issue for index funds because these are not traded like stocks but are instead redeemed directly with the issuer (the index provider).

They are low cost

Although there are some high-cost ETFs out there, they are, in fact, only slightly higher than traditional mutual funds after taking into account their lower expense ratio because of their lower turnover. In other words, ETFs are a lot more tax efficient and cost less to run – another advantage that’s relatively easy for ordinary investors to take advantage of.

They have good liquidity

ETFs generally have excellent liquidity, which means you can trade large amounts without affecting the price as much as what you would see with individual equities. However, it can be an issue as high volatility ETFs such as inverse or leveraged ones where the daily value moves between 1% and -1% instead of by just 1% can experience wide bid-ask spreads during times of market stress.

There are several things you should know about the issuer

Most people buying into ETFs think they[don’t care] [are not concerned with] who issues them, but this couldn’t be more wrong. For starters, you should always check out the issuer of a product to determine its stability and whether it might go under in time. Secondly, issuers have different policies on dividend reinvestment, which can significantly impact your returns over time.

There are several types of ETFs

Many investors think that they can buy into an ETF just like they would buy individual stocks, whereas there are three main types of funds: index-tracking funds, active ETFs and synthetic ETFs. Index tracking funds mirror indices such as the S&P 500 or Dow Jones Industrial Average, where the number of holdings is limited to the actual stocks in the index while active ETFs give you exposure to assets that aren’t in an index through a “specialist” like American Beacon.

ETFs allow for more diversification than mutual funds

ETFs can provide access to trackers based on smaller indices such as sector, country or even gender-specific ones, all of which are difficult to do when investing inside mutual funds. Index mutual funds typically have around 40-50 holdings which won’t put you in proper diversification.


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