We also have a strategy when it comes to investing, utilizing moving averages, exit strategies and strategies indicating when to move back into markets. Strategies can help minimize your risk by giving you a signal to buy, as well as a signal to sell.
Another pitfall that is cited is the tax-efficiency of certain ETFs. Some ETFs are taxed and treated as shares of a limited partnership where one is taxed on a fund’s internal trading activities. Th IRS taxes these funds on the basis that 60% of the activity is long-term and 40% is short-term. As for some commodity ETFs, they are structured as grantor trusts; when shares are sold they are taxed at ordinary income tax rates. The last tax pitfall can be see in leveraged ETFs, which are taxed at short-term capital gains rates regardless of how long they are held. Keep in mind that these pitfalls arise only in a few types of ETFs, as for all the others, they still remain efficient and don’t shoot off the capital gains that their mutual fund counterparts do.
The last pitfall that opponents cite is the riskiness and exposure offered by leveraged ETFs. These ETFs are structured in such a way to give double or even triple the exposure to certain markets in either the same direction or the opposite direction. Before investing in leveraged funds, you should be sure to be fully educated on how they work and their applications. These funds can be beneficial for the right kind of investor.
When it comes to investing, education is your best defense for avoiding the pitfalls of ETFs. We certainly agree that if the necessary research isn’t done beforehand, you can get burned.
Kevin Grewal contributed to this article.