Weighing The Potential Risks and Rewards of ETFs 

ETFs have advantages and disadvantages, which help dictate the kind of investors for which they are best suited.

Benefits and Risks of ETFs

ETFs often have low expense ratios. In addition, ETFs give you access to many kinds of indexes. There are ETFs for individual sector benchmarks, such as the NASDAQ Biotechnology Index; non-U.S. benchmarks, such as the MSCI South Korea Index; and the bond market, including the iShares Barclays Aggregate Bond Fund. ETFs allow investors to target very specific investment opportunities.

ETFs are tax-efficient. Portfolios incur capital gains and a resulting tax liability when appreciated securities are sold. But sales of portfolio holdings in ETFs are infrequent. Like an index mutual fund, index-based ETFs are passively managed and have limited turnover.

ETFs have an additional tax advantage in that they do not experience daily cash flows. Once a block of shares is being traded on the market, ETF sponsors only offer new shares (or redeem old ones) in large blocks to brokerage firms or other sizable shareholders. And when redeeming a block of shares, an ETF typically has the option of doing an in-kind trade, which transfers actual securities to the redeemer rather than cash. In-kind trades do not generate capital gains. ETF managers can use this opportunity to remove securities with a high tax liability, effectively allowing you to delay capital gains taxes until the final sale.

Leveraged ETFs can be complex and may carry substantial risk. Many leveraged and inverse leveraged ETFs are designed for short-term trading since they reset daily and seek to achieve their return objectives on a daily basis. Performance may differ from the performance of the underlying index and may not meet the performance expectations that may be suggested by their names. For more information, you should consult the website of the issuer of the ETF you are considering.

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