5 Reasons an ETF May Not Be Right for You

Learn the disadvantages of ETFs

Although exchange traded funds have many advantages, they have many disadvantages as well, just like any other investment. They might not always be the best fit for every investment portfolio. It's important to understand an investment vehicle before you trade it, but you can consider adding exchange traded products to your portfolio when you have a full understanding of the risk. Consider these disadvantages of ETFs first to make sure they're the best fit for your portfolio before you make a trade.

1
International Limitations

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The U.S. has many, many ETF products, but some countries only have a few exchange traded funds in which you can invest. Regions that do offer market ETFs usually only include large-cap products, leaving a lack of mid- and small-sized funds.

If you want international exposure in your portfolio, additional information can help you overcome the ETF disadvantages involved in foreign investing. You can learn more here: 

2
Low Trading Volumes

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The advantage of purchasing an ETF over an index or equity diminishes when ETFs have low trading volumes. The bid ask spread can be too wide to be cost effective. Barring any unforeseen news or circumstances, market makers tend to be tighter on securities that are more liquid.

3
Long Investment Horizon

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The intra-day trading opportunities created by ETFs might not fit into a long-term investor’s strategy. This is more of an advantage for short-term ETF traders, but it's a disadvantage for long-term traders. It's important to layout your investing goals before you decide how to include ETFs in your portfolio.

4
Inactivity

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Some ETFs aren’t as actively traded as others. This might happen because of a sector-related issue or even due to a regional issue. It might be more effective to invest in a managed fund when activity is higher and this situation occurs.

Although mutual funds have their disadvantages as well, an active mutual fund might be the better fit for your portfolio in the case of inactive ETFs.

5
Tax Implications

In the case of foreign ETFs, there can sometimes be a tax advantage in opting to invest in an international portfolio. Tax laws vary from country to country, so it might be beneficial for your tax situation to find other foreign investments.

There are many benefits in including ETFs in your portfolio, but it's important to understand that they're not the ideal investment for every situation. ETFs should be evaluated on a case-by-case basis for every investing strategy. Understand all the risks involved with ETFs before you get started.

Always Be Aware of Your Risks

As with any investment—a company stock, an index, or other options—make sure you thoroughly research any exchange traded fund before making any trades, either long or short. Conduct your due diligence, watch how an ETF or ETN reacts to different market conditions, take a look under the hood, and see what's in the fund or note. Make sure to consult a broker, a financial advisor, or another financial industry professional if you have any questions or concerns.