ETF Disadvantages
💡 Take Away
Disadvantages of ETFs
- Short-Term Volatility: ETFs can fluctuate significantly in the short term but tend to perform well long-term, making them unsuitable for short-term investments.
- No Direct Ownership: You own shares of the ETF, not the underlying companies, so you have no voting rights at shareholder meetings.
- Temptation to Trade Frequently: Easy trading can lead to speculation instead of long-term investing.
- Impact on Financial Advisors: ETFs are low-cost and accessible, reducing the need for financial advisors.
- General Investment Risks: ETFs are subject to risks like market risk, liquidity risk, and tracking error.
Not All ETFs Are the Same
While ETFs are generally a promising way to invest broadly diversified with minimal effort, not all ETFs offer the same level of diversification.
- Some ETFs are theme-focused and invest in narrower sectors compared to a global ETF.
- The Consumer Advice Center (Verbraucherzentrale) warns that some index providers create indices specifically to include certain companies in an ETF.
-> ETF is not a guarantee of a worry-free, good investment.
Prices Can Fall for a Long Time
- The price of an index or ETF can fluctuate significantly in the short term. During crises, it may even fall for years!
- Volatility always carries a certain level of risk. You need to understand your risk tolerance and decide whether the potential returns are worth the risk.
- If you plan to invest your money for only a short period, an ETF may not be the right choice for you.
- However, historically, indices have always recovered from crises over the long term.
Voting Rights Belong to the Shareholder
Stocks represent ownership in a company. With common shares, the most common type of stock, you gain voting rights in the company. If you own common shares, you can participate in shareholder meetings and vote on matters such as dividend payouts.
When you invest in an ETF, you own a share of the fund, not the underlying stocks directly.
- In the case of physically replicating ETFs, the ETF provider exercises the voting rights.
- For synthetic ETFs, the voting rights remain with the shareholder of the underlying stocks.
No Reward or Punishment Mechanism
When you actively pick stocks, you can influence the market. You can
- reward companies you believe are performing well by buying more shares, and
- punish underperforming companies by selling their shares.
This stock-picking is an important control mechanism for a functioning market economy.
However, with passive investing, this mechanism disappears. As an individual, you benefit because you don’t need to analyze individual companies and can save time.
Constant Availability Can Encourage Speculation
ETFs are traded on the stock exchange, meaning they can be bought or sold during market hours. This constant availability might tempt investors to speculate. Using ETFs for speculation means using a passive product for an active strategy. While this is possible, it undermines the main argument for passive investing: betting on the long-term positive growth of the market.
Financial Advisors Earn Less in Commissions
Accessible, transparent, and cost-efficient—ETFs are particularly attractive to small investors. Passive investing opens up the stock market to a wider audience, leading more and more investors to manage their investments themselves. People are educating themselves independently and investing on their own.
Financial advisors are feeling the impact: If you make a purchase through them, they earn a commission. If you handle your investments yourself, they earn nothing. This disadvantage, however, only affects a specific group: bank and investment advisors.