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ETFs have proven advantages and disadvantages, which help dictate the kind of investors they are best suited for.

Advantage Explanation
Low fees Operation and management fees are typically lower than for index mutual funds.
Trading flexibility Shares can be bought or sold at market prices at any time of the trading day. Investors can use stop and limit orders (if permitted by your broker), sell shares short (subject to exchange rules), or buy on margin (with borrowed money).
Extensive market exposure Available ETFs represent an extremely broad variety of market benchmarks, including large-cap U.S. stocks, sector stocks, emerging markets, and more.
Diversification An ETF is a single security that can represent a well-diversified portfolio of stocks or bonds.*
Tax efficiency The structure of ETFs can significantly limit the potential for incurring taxable gains until the security is sold.

*Diversification cannot assure a profit or protect against loss in a declining market.

Disadvantage Explanation
Brokerage costs Trading into and out of ETFs incurs sales commissions and, possibly, other brokerage fees.
Market pricing There is no guarantee that the market price of an ETF is the same as the market value of the ETF’s underlying securities.
Limited portfolio strategy options Currently, most publicly available ETFs are passively managed and offer investors few opportunities to maximize gains or limit losses through portfolio strategy.
Lack of support Many ETF sponsors provide limited customer support.

Investors should be particularly aware of the risks involved in both leveraged ETFs, which are designed to magnify the returns of the index or benchmark they track, and inverse ETFs, which may allow investors to profit from a decline in the underlying index or benchmark. The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) recently warned investors that such funds are designed to meet their performance objectives on a daily basis only. Over longer periods, returns on leveraged and inverse ETFs may differ significantly from the underlying benchmark; for example, a leveraged ETF designed to double the daily return of an index might actually decline in value over a longer period even if the index records a gain.

Who Why
Investors with large lump sums to invest The fewer trades you make (and the more assets you spread the brokerage fees across), the less you pay in brokerage costs and commissions.
Buy-and-hold investors with a long time horizon The low fees on ETFs mean you keep more of your investment, especially if you don’t trade often.
Sophisticated investors who like to manage their assets ETFs offer an ideal way for sophisticated investors to diversify their portfolios.
  • The ABCs of ETFs
    For a more detailed explanation of ETFs, see our Insights piece.

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