What are the limitations of an ETF?

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ETFs are passive investment tools that track an underlying index and trade on exchanges just like shares. But ETFs need to be bought and sold from the exchange through a broker. You need to have a demat account to trade in ETFs and need to pay commission to the broker for every transaction. If you are tempted to invest in ETFs to capitalize on their real time trading, the commission cost can lower your returns over time.

Secondly, ETFs don’t offer the benefit of rupee cost averaging that is available in mutual funds through SIP. If you want to make regular investment in ETFs, you’ll also have to bear the commission cost on every transaction. ETFs don’t offer features like growth and dividend option where investors can choose an option best suited to their financial goals. For instance, ETFs can’t meet the requirement of a retiree seeking regular income or someone seeking dividend payout on regular basis.

Some ETFs are niche or sector specific and are thinly traded. Investors could face wide bid/ask spread (the deviation in current price of ETF from its NAV) while transacting in ETFs. While ETFs offer intraday trading opportunities that may be tempting in the short-term, they could be detrimental to a long-term financial plan.

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