Australian entrepreneur Darren Herft discusses the disadvantages of ETFs

Exchange-traded funds (ETFs) have become a sought-after alternative to mutual funds. The lower risks and costs associated with them have certainly helped this rise.

While they present investors with a multitude of pros, they are not the holy grail of investments as touted by many financial pundits.

According to AFL aficionado and long-time Australian investor, Darren Herft, Exchange-traded funds (ETFs) have their own unique drawbacks.

“In some cases, especially regarding foreign stocks, ETFs might limit investors to large caps because of fewer equity groupings in the market index,” says Darren Herft.

He goes on to say that the lack of access to mid and small cap corporations leaves highly lucrative growth opportunities out of the reach of Exchange-traded funds (ETFs) investors.

“Long-term players have time horizons ranging anywhere between 15-20 years and they might not be good for the intraday pricing swings that come with Exchange-traded funds (ETFs),” says Darren Herft.

He contends that the swings in hourly prices might cause investors to make more trades than they normally would and derail them from their investment goals.

While many people are convinced that Exchange-traded funds (ETFs) guarantee lower costs, this might not necessarily be the case.

“Exchange-traded funds (ETFs) are usually compared to investing in other funds, but compared to specific stocks their costs are higher,” says Darren Herft.

He goes on to say that brokerage commissions remain the same, stocks present zero management fees to investors.

“More nice Exchange-traded funds (ETFs) are likely to follow low-volume indexes and might lead to higher bids/asks. It might suit many investors to find options in specific stocks,” he adds.

While there are some dividends paying Exchange-traded funds (ETFs), their yields might not give investors the same returns as stocks. This is because investors can choose stocks with high dividend yields, whereas Exchange-traded funds (ETFs) track a broader range of securities.

“The risks may be lower but Exchange-traded funds (ETFs) might not be the best investment option for those who are more risk-tolerant,” says Darren Herft.

Herft cautions investors against speculation and thinks that leveraged Exchange-traded funds (ETFs) that use financial derivatives to amplify the returns of an underlying index need to be carefully examined.

“If held for longer terms, the losses could add up fast,” he says.

He is of the opinion that double-leveraged Exchange-traded funds (ETFs) do not always translate into double returns.

“Investors should do their own research and develop a strong understanding of the investment vehicles they choose,” says Herft.

The Australian entrepreneur thinks that while Exchange-traded funds (ETFs) can be an excellent addition to any investment portfolio, investors should not be blinded by their allure.

“Exchange-traded funds (ETFs) have numerous advantages over other managed funds such as mutual funds, but one needs to know the risks involved.”

He thinks that Exchange-traded funds (ETFs) need highly competent managers to be successful in the market.

“Investment vehicles that live by an index can also die by it, without good steering a downward move is guaranteed,” he adds.

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