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The ETF Book: All You Need to Know About Exchange-Traded Funds, Updated Edition by Richard A. Ferri

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CHAPTER 4

ETF Benefits and Drawbacks

For nearly a century, traditional mutual funds have offered many advantages over building a portfolio one security at a time. Mutual funds provide investors broad diversification, professional management, relative low cost, and daily liquidity.

Exchange-traded funds (ETFs) take the benefits of mutual fund investing to the next level. ETFs offer lower operating costs than traditional open-end funds, flexible trading, greater transparency, and better tax efficiency in taxable accounts. There are drawbacks, however, including trading costs and learning complexities of the product. Informed investors agree that the pluses of ETFs overshadow the minuses by a sizable margin.

In this chapter, we review the benefits and drawbacks of ETFs, including the unique tax advantage inherent in each structure. By the end of this chapter, you should have a clear understanding of the advantages ETFs have over traditional mutual funds and some of the disadvantages. Then you can decide whether they fit with your investment plan.

The Positive Aspects of ETFs

ETFs have several advantages over traditional open-end funds. The four most prominent advantages are trading flexibility, low cost, operational transparency, and tax benefits.

Trading Flexibility

Traditional open-end mutual fund shares are traded only once per day after the markets close. All trading is done with the mutual fund company that issues the shares. Investors must wait until the end of the day when ...

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