It’s easy to get swept up in the hype surrounding exchange-traded funds (ETFs). They’re presented as a simple, time-effective, low-cost, diversified alternative to picking individual stocks. And while it’s true that ETFs have a lot going for them, there are also potential drawbacks that investors need to be aware of.

Here, we explore some of the advantages and disadvantages of investing in ETFs. We’ll look at the potential risks and rewards associated with different kinds of ETFs, and we’ll also discuss the more significant macro factors that can impact ETFs. Being aware of the pros and cons of ETFs can help investors make more informed decisions about how to build a good ETF investment strategy.

ETF basics

An ETF is an investment fund that trades on stock exchanges, just like stocks. The difference between stocks and ETFs is that ETFs are a basket of securities—such as stocks, bonds, or commodities—that track an underlying index. ETFs, like individual stocks, have a stock ticker and can be bought and sold on stock exchanges using an online broker. So you can buy and sell ETFs just like stocks, but underneath they’re actually a collection of stocks or other assets.

Let’s assume you purchase a stock ETF. In that scenario, you’re actually buying a piece of an investment company that owns shares in other companies. It’s like buying a ready-made portfolio of stocks. However, ETF shareholders don’t have direct ownership of the underlying assets. Instead, they own shares in a company that holds those assets. Still, ETF owners are entitled to a share of the profits, such as interest or dividends.

ETFs are passive investment vehicles, which means that they aim to track the performance of an index rather than outperform it. An ETF will simply do whatever the index does—if the index goes up, so will the ETF. And if the index falls, so will the ETF. This hands-off approach has made ETFs a popular choice for investors who want to diversify their portfolio without actively managing it or trying to outperform the market.

Advantages of ETFs

ETFs have many advantages over single stocks and actively managed investment funds. Some of the main benefits of ETFs are that they offer diversification, low costs, simplicity, and good performance over long time horizons. ETFs are beginner-friendly and time-efficient investments. With ETFs, you can invest in a large number of assets with a single investment. A carefully chosen ETF can help build a well-diversified portfolio and potentially beat most stock pickers.

Diversification

One of the best things about ETFs is that they offer individual investors a way to diversify their portfolios with little effort. Diversification is important because it helps to mitigate the risks associated with any single investment. ETFs can do this by spreading your money across a wide range of assets, sectors, and regions. If one of the holdings in your ETF falls, the other holdings will help reduce the losses. This way, you can smooth out the ups and downs of the market.

For example, if all your money is in a few single stocks, it’s vulnerable to company-specific risk—say, if one of those companies has a bad earnings report or faces legal troubles. But suppose you own an ETF that tracks the performance of the overall stock market. Even if one particular company performs poorly, your investment is still diversified across the entire market. This means that it is less likely to be impacted as negatively by any one event. On the other hand, ETFs will never capture the potential gains of a single stock that skyrockets.

Low costs

Another advantage of ETFs is that they are cheaper than other investment options. This is because they generally have low management fees and diversification costs.

ETFs have lower costs than other actively managed funds because no one is picking stocks to buy and sell to beat the market. ETFs that track an index or asset class passively follow what that index does. This means you don’t have to worry about management fees eating into your investment returns.

Diversification costs are lower with ETFs than with buying individual stocks or bonds. You only need to buy one fund to get exposure to many different assets. With individual stocks or bonds, you would have to purchase each asset separately.

Simplicity

An ETF is a type of investment that an investor can just plug into, and it will work without needing to be adjusted or monitored very often. This is different from an active stock or bond portfolio, which usually needs more attention. Of course, you still need to do your research before investing in any ETF, but overall they are much simpler than other types of investments.

Better performance

Diversification and low costs are important, but in the end, investors care about performance. Studies have shown that most stock pickers can’t beat the market. Even professional money managers consistently fail to do so. According to S&P Dow Jones Indices data, only 17-20% of professionally actively managed funds outperform the S&P 500 index. The numbers are similar for other regions. Index ETFs don’t try to outperform the market, they just track it. This means that index ETFs are likely to perform as well as the market they follow over the long run.

Time-efficiency

It’s easy to underestimate how much time and effort is needed to manage a portfolio as it grows. It can quickly turn into a second full-time job and take away free time that should be spent enjoying life. However, if you’re not actively monitoring your investments, you can easily lose track of what is happening. This can lead to making bad investment decisions or missing out on opportunities. With an ETF, you only need to keep track of one investment, saving time and energy.

Lower risk

Good ETFs are considered low-risk investments because they hold many different stocks or other assets. This diversification can help reduce the risk when investing in the stock market. Additionally, ETFs are low-cost, which can help minimize any potential losses when investing in stocks.

ETFs come in all shapes and sizes, with some being riskier than others. However, a globally diversified stock or bond index ETF will invest in a large number of stocks from different countries and sectors. This will help protect your investment if the value of any specific stock, sector, or region drops suddenly.

Disadvantages of ETFs

It’s easy to paint a perfect picture of ETFs, but like any investment, there are disadvantages to be aware of. Some of the main downsides of ETFs are that they can be risky, might not offer as good returns as individual stocks, give investors less control over their portfolio, and there is a lack of exposure to smaller and mid-sized companies.

There are several hidden drawbacks to consider, such as the fact that ETF companies have more and more shareholder control of the firms they invest in and that they have the potential to exacerbate market movements.

Market risk

Even though good ETFs are diversified and considered low-risk, they can nevertheless lose value during a market downturn. This is because the financial markets are unpredictable, and even the best ETFs might fall in worth during a recession or black swan event. While ETFs are frequently advertised as a safe entry point for inexperienced investors, they must be recognized as not being risk-free and possibly resulting in losses.

Opportunity cost

An index-based ETF can only offer average returns. This implies that ETF investors may miss out on significant growth potential by not picking individual stocks. Investors seeking superior returns must be prepared to take greater risks and losses. For example, someone who invested in Amazon, Google, or Tesla in the early days would have made a killing compared to someone who just bought an index ETF.

Lack of control

Investors give up some control over their portfolios by investing in an ETF. For example, an investor in an S&P 500 index ETF has no say over the stock-weighing in the fund. This can be a problem if you want to invest in stocks that match your values or if you have strong knowledge or an opinion about a particular stock. Traditionally, shareholders invest in stocks they believe in or think are undervalued. But this isn’t possible with an ETF, and it undermines the charm of active investing for some people.

Missing mid and small-caps

Most ETFs are focused on large-cap stocks because they’re more liquid, less volatile, and easier to trade. While this provides stability, it doesn’t expose investors to the high returns that mid and small-caps have historically generated. However, a few ETFs focus on mid and small-cap stocks, and these can be a way to get exposure to these types of companies. That being said, small caps can be riskier than large caps, so investors must be aware of this before investing.

Giving ETF companies too much power

As ETFs have become more popular, the companies that manage them have amassed more and more power. When investors buy an ETF, they’re also giving the company permission to vote on their behalf on corporate matters. For example, BlackRock, Vanguard, Amundi, and Invesco are some of the largest ETF providers. They now have voting power over many of the world’s biggest companies. The shift from direct shareholder ownership to indirect ownership through ETFs has led to a concentration of power among a few firms, which can be problematic.

Amplifying market movements

ETFs are associated with greater co-movement of asset prices, and the massive flows into and out of ETFs increase stock volatility. ETFs have been found to spread liquidity crises to the underlying equities, suggesting that when ETFs become illiquid, this can also harm equity liquidity. Second, when demand shocks hit the ETF share prices, this can also significantly influence equities. Third, higher ETF ownership of equities increases volatility, especially during market turmoil.

Stock index ETFs pros and cons

The most popular types of ETFs are those based on stock indexes. A stock index is a collection of stocks representing how a stock market is doing. For example, the S&P 500 is an index of 500 large US companies. The UK has the FTSE 100, an index of the 100 largest companies in the UK. Other countries have their own indexes, and some indexes track stocks from multiple countries.

Pros of index ETFs

There is voluminous research saying individual investors are terrible stock pickers. Studies have shown that even professional fund managers who are paid to pick stocks cannot outperform the market over the long run. There are even studies that suggest monkeys can pick stocks better than professionals. If you follow this school of thought, you shouldn’t bother trying to pick stocks at all.

Instead, investors can buy a stock index ETF and get the market’s average return. This is known as index or passive investing. Over time, a well-diversified index ETF will outperform most active investors. By buying a stock index ETF, investors are diversified across hundreds or even thousands of stocks. This easy access to broad ownership can potentially reduce risk and volatility because investors are not relying on any one company’s performance. This is difficult and time-consuming to achieve with individual stocks.

ETFs can typically be bought commission-free or at very low costs at most major online brokers. While most ETFs are not free to own, the best ones have very low expense ratios. Actively managed funds, on the other hand, typically have higher fees. This is because ETFs tracking an index don’t need to pay fund managers to pick stocks. ETFs can also pay dividends or accumulate those dividends and reinvest them.

Cons of index ETFs

Of course, no investment is without risk. Investing in a stock index ETF means you’re buying whatever the market does, good or bad. In years when the stock market falls, your investment will fall too. This is why it’s important to have a long-term investment horizon when investing and carefully research the ETFs you’re considering before investing. Because of tracking errors, some ETFs outperform others. This implies that the ETF may not track the index it is supposed to follow as closely as you would like.

Many people are fleeing to the stock market because they are losing money to inflation, poor bond returns, and high real estate values. They get caught up in the hype of ETFs, and they invest without understanding what they’re buying. There’s no guarantee that the stock market is a good place to park money. While a well-diversified global equity portfolio can potentially produce good results over the long run, there can be substantial risks in the short term. For example, the world markets plummeted dramatically in February 2020, and someone who needed to sell their ETFs to access cash could have lost a significant amount of money.

Another danger of index ETFs is that they are concentrated in the hands of a few fund managers. This means that a small number of big institutions own a lot of shares in public corporations. Some people are concerned about this because it could give these institutions too much power. Some people are afraid that investment managers are buying so many shares of some companies that they will be able to control them. When value moves from companies to these investment funds, it might lead to less competition and innovation. For example, BlackRock, the largest ETF manager, has become one of the world’s most valuable companies within a few decades despite not owning any factories or products.

Bond ETFs pros and cons

Investors have long been advised to hold a mix of stocks and bonds because it gives them a healthy balance of rewards and risks. However, bonds are different from stocks because in that they are loans. When you buy a bond, you’re buying debt that a company, government, or municipality has issued. Bonds make periodic payments (coupons) and return the principal when they mature. The coupon payments are typically fixed, and the maturity date is known in advance. Government bonds from developed countries are considered some of the safest investments in the world.

Bond ETFs are a type of investment fund that invests in multiple different types of bonds. There are different kinds of bond ETFs, some focusing on the whole market and others focusing on specific parts of the bond market, such as corporate or government bonds. The bond market can be difficult to understand, so ETFs offer a way to invest in bonds without having to pick individual ones.

Bond ETFs are similar to individual bonds, but they are different in a few ways. With bond ETFs, you usually get payments every month instead of every six months. This is because bond ETFs are a collection of different types of bonds. At any given time, some bonds in the portfolio may have payments, while others don’t. And some may be maturing while others aren’t. Another difference between bond ETFs and individual bonds is that bond ETFs do not have a maturity date. This is because the portfolio of a bond ETF is always changing as bonds mature and are replaced with new ones.

Pros of bond ETFs

Bond ETFs have many advantages. They offer diversification, low fees, high liquidity, and easy reinvestment of coupons and maturity proceeds. The benefit of investing in bond ETFs is that when you buy them, you are buying hundreds or even thousands of different bonds at the same time. This lowers risk because it’s unlikely that all the underlying bonds will fall at once. So rather than researching several bonds and wondering whether they will stay safe and mature on schedule, bond ETFs offer investors the ability to invest in the kinds of bonds they want with a single click.

Another benefit of bond ETFs is that they offer individual investors a way to cheaply get basic exposure to benchmark bond indexes. For example, there are bond indexes that track investment-grade corporate bonds and government bonds from around the world, such as the Global Aggregate Bond Index. These indexes are difficult and expensive for individual investors to replicate on their own, but they can be cheaply accessed through ETFs.

Bonds have a higher degree of safety than stocks, but they also have lower returns. However, a bond ETF can provide regular income through its monthly payments. ETFs that invest in bonds may be a source of income without worrying about the maturation or redemptions of single bonds. This is because bond ETFs make it simple to calculate your monthly earnings from the automatic payments they make.

Cons of bond ETFs

Bonds ETFs have many advantages over individual bonds. However, they also share many of the same drawbacks. These downsides include lower returns than stocks, interest-rate risks, no guarantees of principal, and expense ratios that may be high.

The bond market is the investment choice for individuals who want stability and income. However, bonds have produced much lower returns than stocks ETFs. The payments (coupons) on bonds are fixed, and they do not go up with inflation. In contrast, stock prices tend to go up over time as companies grow and become more profitable.

Another downside of bonds is that they are subject to interest-rate risk. This means that when interest rates go up, the prices of bonds go down, and reversely This happens because when rates rise, new bonds are issued with higher coupons, making existing bonds less attractive. Bonds ETFs, especially long-term funds, can easily turn against you if rates go up too much.

While bonds are free to hold, bond ETFs have expense ratios, the fees that funds charge to cover their operating expenses. Bond ETF expense ratios may be high, and investors should be cautious that they are not detracting from their returns. These fees might quickly transform modest bond yields into almost nothing.

S&P 500 ETFs Pros and Cons

The Standard and Poor’s 500 or S&P 500 is a stock market index that tracks the performance of 500 of the largest companies in the United States. The S&P 500 is the most popular investment index among US investors. It’s also popular among non-US investors because the US plays a dominant role in the global economy. An investor interested in investing in the US economy but not in picking individual stocks may purchase an S&P 500 ETF.

S&P 500 ETFs offer several advantages. They give you exposure to some of the most successful companies in the US, which have a history of outperforming the rest of the world. They are also a low-cost way to invest, and they offer indirect global diversification. The most significant disadvantage of S&P 500 ETFs is that they do not offer true diversification, which makes them risky if the US economy performs poorly in the future. They are also affected by domestic and global politics and economics in the United States, which is turning increasingly unpredictable.

S&P 500 pros

The main benefit of investing in an S&P 500 Index ETF is that the US is home to the world’s largest, most liquid, and most successful financial markets. By investing in an S&P 500 ETF, you get exposure to a large and diverse group of companies with a long history of outpacing the rest of the world.

The United States has the largest proportion of companies in global stock indexes. This number has grown from around 44% in October 2011 to 60% in May 2022. No other country has a double-digit weighting, and all other Western industrialized countries have seen their numbers decline. Furthermore, 65 of the world’s 100 largest public companies by market cap are based in the US. In 2020. The market cap of US tech stocks alone was more valuable than the entire European stock market.

US companies also have the advantage of being able to settle transactions in their own currency. This is beneficial because the US dollar is considered the world’s reserve currency and a safe haven in times of market turmoil. When the value of the US dollar rises against other currencies, the US stock indexes tend to rise. This likely happens because when investors put their money into US stocks, they must buy dollars first. When then the demand for dollars rises, US stocks become more valuable.

The S&P 500 is not well-diversified at first sight. It only tracks large US companies. But many of the largest companies in the index have a global presence. They get around 40% of their revenue from outside of the US. So this can be helpful for investors who want international exposure but believe that the US is the best growth potential.

S&P 500 cons

The most significant disadvantage of S&P 500 investing is that it does not provide true geographical diversification. While American companies generate a large proportion of their income from abroad, they ultimately rely on the US economy and politics. A diversified portfolio distributes risk by including equities from a variety of countries. This can smooth out the upsides and downsides of investing in a single market. But as we’ve seen in the past, when the US sneezes, the rest of the world often catches a cold.

It’s not certain if the good performance of the US stock market will continue. On the one hand, some investors feel that because the US stock market has done much better than other markets, they don’t need international diversification in their portfolios. Because American companies are getting bigger, more valuable, and grabbing a larger portion of the worldwide market share, they believe there is no indication that this pattern will reverse anytime soon.

However, history suggests that worldwide diversification may boost returns while also reducing risk. Performance winners often move from one region to another over time. One example of how dramatically things can change is the stock market in Japan. The Nikkei stock index was doing really well until 1989 when it peaked and then crashed. The Nikkei has never regained its high value, and today it is worth around half of what it used to be. A Japanese person who invested in the Nikkei stock market index in 1988 might have thought that they were losing out by investing in something other than the Japanese stock market.

A similar scenario played out in the US during the 2000s that had many investors worried about the future. The S&P 500 had negative returns for 10 years from January 2000 to December 2009. This was a big change from the 10% annual returns the index had delivered before 2000. During that period, the index did not do as well as some other international markets. If you had invested in internationally diversified stock index ETFs at that time, you would have earned better returns while also benefiting from the eventual resurgence of US equities.

Another thing to remember is that the S&P 500 index is a free-float weighted index. This means that the larger the company, the more influential it is on the index. The top 10 companies in the index make up more than 29% of the index as of May 2022. So when these companies do well, the index does well. But if they have a bad year, it can drag down the whole index.

Developed Markets ETFs pros and cons

In investing, a developed market is loosely defined as a country with a sophisticated economy and a high level of economic development. A developed markets ETF will include stocks from North America, Western Europe, Japan, and Australia. Developed markets tend to be more stable and predictable than emerging markets, making them attractive to some investors. However, they also tend to have lower growth potential because they are already well-developed.

The term developed market is chiefly defined by two stock market indexes: the MSCI World Index and the FTSE Developed Index. The MSCI World Index includes 23 developed countries, while the FTSE Developed Index covers 26. These indexes are generally well-correlated, meaning that they tend to move in the same direction. To invest in a developed market index, you can buy a fund that tracks either index.

The main advantage of a developed markets ETF is it offers exposure to a variety of large, stable companies. These companies tend to have strong balance sheets and generate consistent profits. The disadvantages of developed markets ETFs include the potential for lower returns than other asset classes, such as emerging markets stocks, and the risk that a broad market index may not adequately reflect the performance of individual companies.

Pros of developed market ETFs

The benefit of investing in a developed market ETF is that you get diversification across various large companies from the world’s most developed countries. This can help reduce the risk associated with investing in a single developed market while also providing the potential for good returns. As developed markets exclude countries with less stable financial systems, they tend to be more stable and predictable.

An ETF that invests in developed markets exposes investors to over 20 countries and thousands of companies. It doesn’t rely on the performance of a single market, which can be more volatile. For example, suppose the US stock market is doing poorly. In that case, investors in a developed market ETF will still have money invested in large, developed economies like Germany, Switzerland, and Australia. 

The MSCI World and FTSE Developed World indexes have fairly strict requirements for inclusion, which results in a diversified portfolio of high-quality companies. For example, to be included in the FTSE Developed World Index, a country must have sophisticated, well-regulated equity, foreign exchange, and derivatives markets. Other requirements include a sophisticated brokerage landscape with high transparency, broad liquidity, efficient trading mechanisms, etc.

Cons of developed markets ETFs

The main argument against developed markets ETFs is that they rely too heavily on the US stock market. The top holdings of the MSCI World Index and FTSE Developed Index are both heavily concentrated in the US, with over 60% weighting towards the US stock market. Similarly, the main driver behind the performance of these indexes has historically been the US stock market. This means that investors in developed markets ETFs may not be as diversified as they think.

While developed markets are typically more stable than emerging markets, they also have slower growth potential. They offer less opportunity for upside potential. Many developed economies are considered to be mature. While this can provide some stability, it also limits the amount of room for growth. For example, the UK’s FTSE 100, Italy’s MIB, and Japan’s Nikkei 225 have been stuck in stagnation for over two decades now.

Emerging Markets ETFs Pros and Cons

Emerging markets are defined as countries that are industrializing and experiencing rapid economic growth, such as Brazil, Russia, India, and China. They are typically thought to have higher risk but also higher potential returns than developed markets. An emerging market ETF is an easy way to get exposure to foreign markets that have traditionally been difficult to research and expensive to invest in.

An emerging markets ETF can offer high returns and geographical diversification that is not found in developed market indexes. Emerging markets are less correlated to developed ones, meaning they can offer new dimensions. They also tend to have higher growth rates because they are at an earlier stage in their economic development.

The main risk with investing in emerging markets is that they are more volatile and less predictable as they are transitioning economies. Political instability, corruption, and currency risk tend to be higher in emerging markets. That’s why stocks from developing countries are usually added to an existing portfolio instead of making up the whole portfolio, according to the investor’s risk profile.

Pros of emerging markets ETFs

Although US companies have an increasingly bigger share of the investable market, they are making up a smaller and lesser proportion of the overall global economy. Emerging markets can offer an opportunity to tap into the growth potential of many foreign economies that are expected to expand rapidly in the coming years. For example, China and India have been growing rapidly and are expected to continue doing so.

An emerging markets ETF can provide access to foreign markets and companies that may be difficult to invest in otherwise. They are a convenient and fairly cost-effective way to get exposure to a broad range of emerging markets. ETFs trade on major exchanges and can be easily bought and sold like stocks. They are also more liquid than many individual emerging markets.

Cons of emerging markets ETFs

Critics of investing in emerging markets argue that there is no guarantee that these countries will eventually embrace Western-style capitalism and the free market approach. The theory is that as developing countries become more developed, they will start to want more democratic institutions and economic liberties. However, this is not always the case. For example, some countries are taking a more protectionist stance, like China.

The other main concern about investing in emerging markets is that they are simply too risky. Many developing countries have unstable governments, high levels of corruption, and unreliable legal systems. These factors can lead to sudden changes in economic conditions that investors may not be able to predict or protect themselves from.

The idea that all countries will eventually come to resemble the West was to some degree developed by Francis Fukuyama in his “The End of History.” He argued that the victory of capitalism after the fall of the Soviet Union would lead to the globalization of Western liberal democracy. Whether this is happening in the way that Fukuyama predicted is questionable, and some countries are instead pursuing different development models.

Others see a different scenario play out, where it becomes “the West vs. the rest,” such as Fukuyama’s main opponent, Samuel P. Huntington. In his book, “The Clash of Civilizations,” Huntington argues that the primary axis of world politics will be between Western civilization and the rest of the world. In the place of integration, he envisioned a world of competing civilizations, each with its own distinct culture, values, and economic interests. This is a much more pessimistic view of the future of international relations and trade.

International ETFs Pros and Cons

An international or global index tracks stocks from both developed and developing markets. These global indexes cover around 45 to 50 different countries and thousands of different large and mid-sized companies. The two main global indexes are the MSCI ACWI and the FTSE All-World Index. You can get access to these and other global indexes through ETFs that copy their performance. Both the MSCI ACWI and FTSE All-World indexes provide exposure to the US, developed countries, and developing countries, in one package.

Individual investors may benefit from investing in a global index ETF because it is an inexpensive method to gain worldwide diversification. This means that with a single ETF, investors can get exposure to many different countries. In the past, this would have been too complex or expensive for most retail traders. For example, the FTSE All-World covers approximately 4,000 holdings in nearly 50 countries, including both developed and emerging markets.

However, world index-based ETFs are not perfect. They have some of the same risks as other ETFs, including country risk, currency risk, and political risk. Primarily, the risks associated with developed markets and emerging markets still apply. Performance-wise, global indexes have produced poorer results than the S&P 500. So with a global index ETF, investors have previously suffered an opportunity cost by choosing country diversification over concentration.

Pros of global index ETFs

The advantage of global index ETFs is that they provide exposure to stocks from a large number of countries, except for the more risky frontier markets. They’re considered to be the most diversified form of ETF investing. Diversification at this level may reduce concentration risk and smooth out some of the ups and downs of investing in any one country, even if the investor doesn’t have the time or knowledge to follow equities from foreign markets.

Passive investing with global indexes ETFs is unbiased and a lot easier than trying to pick stocks from around the world. Investors can put their money into one ETF and let it do the work for them, rather than relying on their own ability to find the best stocks in each country. As such, it’s a country and sector-neutral way of investing.

The funds are automatically realigned between countries, sectors, and individual companies. This helps fight home-country bias as well as the arbitrary personal decisions that investors tend to make when they are actively picking stocks. In other words, global ETFs are not influenced by what’s hot right now. They stick to a set index, which means they go wherever the money flows.

Cons of global index ETFs

The main disadvantage of global index ETFs is that they provide broad diversification but not deep diversification. For example, the FTSE All-World Index includes companies from several countries. However, it still has around 60% of its holdings in the US stock market. Its top constituents are almost the same as the S&P 500, with the exception of a few Asian companies. So while global index ETFs provide some diversification, they may not be as diversified as you would like.

Another disadvantage is that global index ETFs is they can never outperform. A global ETF, and any other ETF for that matter, will always rebalance after the fact. Meaning that it will never make a bet on the future but only follow what has already happened. So if you’re looking to get ahead of the market, a global index ETF is not the way.

Because these funds track a global index, they’re dragged down by the average and poor performers and will always do worse than the best-performing stocks in the index. If US stocks pick up their rally, a global index will benefit but not to the same extent as a US-only ETF. Similarly, if emerging markets are doing well, a global index will participate in the gains but not to the same degree as an emerging markets ETF.

The bottom line

The exchange-traded fund is no doubt one of the most significant innovations in the investment world. It’s a simple, low-cost way to invest in a diversified basket of assets. However, like all investments, ETFs come with risks and rewards that need to be considered before investing. By understanding the pros and cons of ETFs, investors can make informed decisions about whether they are right for their portfolios.

The author held long positions in developed and developing market ETFs at the time of publication.