Are ETFs always the right choice?
Cash: If you want to hold cash, it’s usually better to do so using an ISA or savings account rather than a money market ETF. A competitive deposit account should earn a higher interest rate, there won’t be any dealing fees, and the maximum level of compensation is greater for cash in the bank versus an ETF provider.
Temptation to overtrade: Many traders (including hedge funds) use ETFs. But excessive trading can increase costs and potentially reduce returns. Some people find it easier to buy and hold using a less flexible index fund. If that’s you, then an old-school fund may be a better psychological fit.
Not always cheaper: Occasionally the lowest cost index fund will be a smidge cheaper than its ETF equivalent. This is something to look out for in well-served markets such as FTSE 100 trackers.
High-risk products: Leveraged and short ETFs are highly specialised investments that are mainly intended for short-term use by institutional players. Only invest in niche products if you are absolutely sure you understand the risks.
Illiquidity: While most ETFs are very liquid, some small and niche ETFs may rarely trade. Low trading volumes can mean a costly bid-offer spread. An appropriate mutual fund may be a better alternative.
No outperformance: An ETF aims to match the returns of its index. Investing your money with an active fund manager can work out better periodically, especially if you get lucky. Pitted against that hope is the firm evidence from numerous studies that active funds fail to beat index-tracking products on aggregate.
The decisive advantage The rise in popularity of ETFs is no accident. Most investors find that an ETF portfolio enables them to easily execute their investment strategy – whether they want to build wealth or live off income. Naturally, it’s always best to do your research first.
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