ETFs DO Have Their Drawbacks

by Ron Haynes

I’ve spent quite a lot of time comparing ETFs to individual stocks and to mutual funds. There are TONS of advantages to investing in an ETF versus investing in those other investment vehicles but ETFs do have two main drawbacks with respect to mutual funds and individual stocks:

  1. Commissions
  2. Selection

Commissions

Whereas you can usually buy and sell mutual funds without paying any transaction costs, you must pay a commission every time you buy or sell an ETF. Commissions may be charged on a per-share basis or as a flat fee per transaction depending on your individual online broker. Commissions for online trades can range from about $4 to $10 per trade (depending on which online brokerage you use), whereas commissions for trades made over the phone or by your broker can cost quite a bit more.

Commissions and Dollar-Cost Averaging

Having to pay commissions to buy ETFs can make it impractical to use an investment strategy known as dollar-cost averaging (unless you’re a ShareBuilder customer!). With dollar-cost averaging, you buy the same investment at certain intervals over an extended period of time. The purpose of dollar-cost averaging is to reduce risk by not buying an investment all at once, only to see it plunge in value the next day due to a sudden downturn in the market. For instance, rather than buy $12,000 worth of a mutual fund all at once, with dollar-cost averaging you might buy $1,000 worth of the same fund once a month for 12 months. Dollar-cost averaging into a directly purchased mutual fund would cost you nothing, whereas doing so with an ETF would cost at least $4 – 10 per transaction.

Selection

Though it’s true that there are hundreds of different ETFs and more being offered every month, there are roughly 10,000 mutual funds and 7,000 individual stocks. If you’re interested in buying a very narrowly focused investment, it may currently be impossible to gain exposure to that investment by buying an ETF. For instance, if you believe that the stocks of Eastern Europe–based companies will increase in value, you have several different mutual fund options, or you can buy any of the individual stocks of companies from that region.

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Currently, it’s difficult or impossible to replicate certain types of investments by buying an ETF. That said, for the average investor, it’s usually not necessary—and often highly risky—to buy the types of investments not yet covered by ETFs. As more ETFs come to market, the industry is bound to gain more funds that focus on specific market niches.

How to buy ETFs

You’ll have to open an account at a brokerage company. Click the links below to get further information:

  • Scottrade – you can buy Focus Morningstar ETFs commission free!
  • Etrade – E*Trade helps you get started investing in three easy steps
  • TradeKing – offers regular trades and broker assisted trades for only $4.95
  • tradeMonster – offers mobile trading
  • Zecco – has commission free trades available
  • ShareBuilder – invest for only $4 on an automatic investment plan

About the author

Ron Haynes has written 987 articles on The Wisdom Journal.


The founder and editor of The Wisdom Journal in 2007, Ron has worked in banking, distribution, retail, and upper management for companies ranging in size from small startups to multi-billion dollar corporations. He graduated Suma Cum Laude from a top MBA program and currently is a Human Resources and Management consultant, helping companies know how employees will behave in varying situations and what motivates them to action, assisting firms in identifying top talent, and coaching managers and employees on how to better communicate and make the workplace MUCH more enjoyable. If you'd like help in these areas, contact Ron using the contact form at the top of this page or at 870-761-7881.