Can't Outperform the Benchmark
As with index mutual funds, index-based ETFs do not attempt to outperform their benchmark index. That’s the potential upside of actively managed funds or ETFs—and why investors may be willing to pay more for these instruments.
Leveraged and Inverse ETFs
Leveraged and inverse ETFs are not designed for buy-and-hold investors who are trying to track an index over a long period of time. Rather, these investments are intended for very aggressive, sophisticated investors who actively manage their investments daily. Because of compounding, leveraged and inverse ETFs are not likely to track the performance of a benchmark index over extended periods. Therefore, holding them long term may entail considerable and unnecessary risk.
"Costs" Using ETFs
Finally, with the tremendous growth associated with ETFs, you should know there are “costs” associated with the benefits of ETFs. Before you invest, do your due diligence to understand the structure of the ETF and its associated risks and tax implications. Many investors may not be aware that some products commonly referred to as ETFs are not funds at all. An example of this is exchange-traded notes, or ETNs. These products have counterparty risk because they are notes or structured debt, while others are set up as partnerships, which can mean greater tax complexity such as filing multiple state tax returns.
In next blogpost, we will discuss how do you use ETFs.