Pros and cons of ETFs

Like any investment type, exchange-traded funds (ETFs) have their strengths and weaknesses, and proponents and critics:

  • Pro: accessibility. Can be an effective way to get exposure to a diversified portfolio of stocks, bonds or other assets.
  • Pro: low costs. Generally lower fees than index mutual funds.
  • Pro: transparency. More transparent than actively managed mutual funds because holdings are known at all times.
  • Pro: tax efficiency. Tax efficient because you generally only pay capital gains taxes when you sell; there are few (if any) taxable distributions (see ETFs and taxes).
  • Con: too many ETFs? Many duplicative ETFs have come on the market that can be hard to choose among. Critics say there are already too many ETFs.
  • Con: ETFs getting narrower. ETFs have become more narrowly focused, making them potentially more volatile and risky. Critics say ETFs' reputation as a low-cost broad investing vehicle is endangered by the new specialized ETFs.
  • Con: speculative temptation. The ease of trading ETFs can make them conducive to short-term investing and the temptation to chase the latest hot sector.
  • Con: commissions can add up. If you buy and sell too many small lots of ETF shares, you may end up paying more in brokerage commissions than the fees you’re saving on comparable mutual funds.