What Are the Pros and Cons of Investing in ETFs?

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What Are the Pros and Cons of Investing in ETFs?

Exchange-traded funds (ETFs) are a type of investment product that has grown in popularity in recent years; however, investors should consider both their advantages and disadvantages before investing in one. This article will outline some of the key pros and cons of ETFs. By understanding the benefits and drawbacks of these products, investors can make a more informed and prudent decision in deciding whether to invest in one.

Pros of Investing in ETFs

ETFs offer some distinct advantages that appeal to many investors. The key benefits are:


ETFs offer a simple, efficient way to diversify a portfolio. ETFs vary in focus and provide exposure to different markets, sectors and asset classes. This can help spread risk, meaning that when one part of the portfolio underperforms, another part may still generate returns. ETFs also allow investors to reallocate assets quickly and easily, enabling them to adjust their strategy to match changing market conditions. 1

Tax Efficiency

Because of the way ETFs structure their investments, they often result in fewer taxable events, or the occasions which are subject to capital gains tax. This can be especially advantageous for investors who actively trade their investments often, as capital gains tax can represent a large part of their total expenses. 2

Low Costs

ETFs often have lower cost structures than other investment products. Many ETFs have much lower expense ratios than their traditional counterparts, and often there is no commission charged when investors buy and sell the ETF. This can help to improve the overall returns of ETFs, as costs are a major factor in determining the profitability of an investment. 3

Cons of Investing in ETFs

Although ETFs offer many advantages, investors should be aware of some potential drawbacks as well. These include:

Tracking Error

ETFs are designed to match, or track, the performance of an index or benchmark. However, this ‘static’ approach may result in tracking error, which is the difference between the fund’s performance and the index or benchmark it tries to replicate. This error can be due to factors such as costs, taxes, or changes to the composition of the index or benchmark. 4

Lack of Flexibility

ETFs are generally passive investments, meaning that they are unable to adjust their strategy in response to market conditions. This may limit the potential for higher returns and make them less suitable for more complex or dynamic investment strategies. It also means that investors need to be mindful of the particular focus of the ETF they are investing in and how it could be affected by market fluctuations. 5

Liquidity Risk

Unlike listed stocks, ETFs are not guaranteed to have a constant and abundant supply of buyers. This means that investors should carefully consider the liquidity of ETFs before investing; if there are not enough buyers to meet the trade demand, then investors may not be able to exit their positions quickly, or even at all. 6


Exchange-traded funds can offer many advantages to investors, including diversification, tax efficiency, and low costs. However, it is important to consider the potential drawbacks of ETFs too, such as tracking error, lack of flexibility, and liquidity risk. Ultimately, investors should weigh up all the pros and cons in order to decide whether ETFs are suitable for their individual needs and investment strategy.


1. ETFs: Pros and Cons (CFA Institute)

2. What is an ETF? Advantages & Disadvantages of ETFs (Cornerstone Advisory)

3. Pros and Cons of ETF Investing (Investopedia)

4. What are the advantages and disadvantages of ETFs? (Schroders)

5. Benefits and Risks of Exchange-Traded Funds (ETFs) (Fidelity)

6. ETFs: Advantages & Disadvantages (The Ohio State University)



December 29, 2022

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