Exchange-Traded Funds (ETFs): Benefits and Potential Drawbacks

Potential Benefits of Investing in ETFs

• Lower Fees: ETFs are often less expensive than comparable mutual funds, though costs can vary. Additionally, ETFs usually don’t charge the buying, selling or marketing fees more common with mutual funds.
• Liquidity: ETFs trade throughout the day like shares of stock. That means they generally offer better liquidity than comparable mutual funds.
• Access to Diversification: ETFs offer a relatively cost-efficient way to diversify an investment portfolio. Investors who lack the funding to properly diversify a portfolio with individual securities may find ETFs useful. (If you have larger amounts to invest, we believe other options may do a better job helping you reach your long-term investing goals. More on that below.)

Potential Drawbacks of Investing in ETFs

• Lack of Personalization: ETFs are not tailored to your investment goals. That means accommodating your unique needs can be difficult with ETFs. For example, most ETFs won’t allow you to restrict certain companies from your portfolio. If you’re a high net worth investor, you may be better off having a customized portfolio tailored to your preferences and designed to achieve your individual financial goals.
• Tax Disadvantages: ETFs may limit your ability to minimize capital gains taxes. This is an important consideration for some high net worth investors. While ETFs may be more tax efficient than mutual funds, offsetting capital gains with capital losses is often much easier with individual stocks and other securities.
• Less Cost-Efficient: If you own a larger portfolio, buying individual stocks and bonds may be more cost-efficient than investing in an ETF. With a larger portfolio, the relatively small ETF fees could add up and eat into performance.
• Overconcentration: You may unintentionally derail your asset allocation strategy if you invest in multiple ETFs with similar fund holdings. That’s because too much overlap in holdings could lead to overconcentration. In addition, holding too much of a single asset can add unintended risk to the portfolio. We believe true diversification means understanding how each of a portfolio’s components works together to meet your long-term objectives.

Possible Tax Implications of Owning an ETF vs. Owning Individual Securities

Consider a hypothetical ETF with a net annual return of 0%. This ETF has two securities: one experienced significant gains during the year, while the other experienced heavy losses. An investor in the ETF may not be able to offset capital gains in the overall portfolio if the ETF itself didn’t lose value. If the investor owned the underlying securities, however, harvesting the losses from the security that fell significantly may be possible.*

*The contents of this document shouldn’t be construed as tax advice. Please contact your tax professional.