Exchange-traded funds (ETFs) are investment vehicles that have become increasingly popular among traders and investors because they offer the benefits of both stocks and mutual funds, making them a convenient option for those who want to diversify their portfolios. While ETFs are typically considered short-term investments, traders can also hold them long-term. However, traders must consider the long-term advantages and disadvantages of holding ETFs before making investment decisions.
Advantages of Holding ETFs Long-term
ETFs offer several advantages when held long-term, making them an attractive investment option for traders in Singapore. Acknowledging the long-term benefits of ETFs has convinced many traders to hold them for extended periods to reap higher returns. Holding ETFs long-term might only be suitable for some traders, and it is vital to understand the advantages before making any investment decisions.
Tax Benefits
One of the notable advantages of holding ETFs long-term is the potential tax benefits. In Singapore, ETFs are considered a form of unit trust and are exempt from capital gains tax. Therefore, traders can sell their ETF units without incurring any taxes on profits made. Unlike traditional mutual funds, ETFs do not distribute dividends directly to investors. Instead, they are reinvested into the fund, reducing the tax liability for traders. This tax-deferred growth can significantly impact long-term returns and especially benefit high-net-worth individuals.
Another tax advantage of holding ETFs long-term is the ability to use capital losses to offset capital gains. Therefore, if a trader sells an ETF at a loss, they can use that loss to reduce their taxable income from other investments. It can minimise taxes and increase the overall after-tax returns for long-term investors.
Diversification
ETFs offer traders diverse investment options, making them an ideal choice for long-term holdings. Unlike individual stocks, which are subject to market volatility and company-specific risks, ETFs expose a wide range of assets, such as stocks, bonds, commodities, and currencies. This diversification helps reduce overall risk in a portfolio and can result in more stable long-term returns.
In Singapore, several ETFs track different sectors or indices, allowing traders to invest in specific industries or regions. It will enable traders to diversify their portfolios according to risk tolerance and investment goals. ETFs offer a cost-effective way to access international markets, which can be challenging for individual investors due to currency exchange rates and regulatory barriers.
Lower Fees
Compared to traditional mutual funds, ETFs have lower management fees, making them an attractive option for long-term investors. Mutual funds typically charge annual fees ranging from 1 to 3%, while ETFs have an average expense ratio of less than 0.5%. This difference in prices can significantly impact a trader’s long-term returns.
Since ETFs are passively managed, they do not incur high trading costs associated with actively managed mutual funds. It can result in lower fees and reduce the return drag for long-term investors. ETFs also have no sales loads or redemption fees, making them a more cost-effective option for short-term and long-term traders.
Disadvantages of Holding ETFs Long-term
While there are several advantages to holding ETFs long-term, it is essential to consider the potential drawbacks before making any investment decisions. Although these disadvantages may not apply to all traders, understanding them can help investors make more informed choices regarding their portfolios.
Market Volatility
ETFs are subject to market volatility, just like any other investment. While ETFs offer diversification and can reduce overall risk, they do not eliminate it. Traders holding long-term ETFs may be exposed to potential losses during exchange-traded funds market downturns. If the underlying assets of an ETF perform poorly, it can negatively impact the value of the ETF.
It is also worth noting that ETFs may experience more significant price fluctuations than traditional mutual funds because ETFs are traded on an exchange subject to market demand and supply, unlike mutual funds, which are priced daily at NAV.
Tracking Error
ETFs typically track a specific index or sector, and as such, their performance is tied to the underlying benchmark. However, no fund can replicate an index perfectly, resulting in a tracking error. Therefore, the ETF’s performance may deviate from its norm due to various factors such as management fees, market liquidity, and trading costs. While this may not significantly impact short-term returns, it can affect long-term performance.
Certain ETFs may have a higher tracking error than others. For example, leveraged and inverse ETFs aim to track multiple or opposite returns of an index. However, due to their complex nature and daily rebalancing, these ETFs tend to have higher tracking errors and are unsuitable for long-term investors.
Lack of Control
Unlike individual stocks, ETFs offer little control over the underlying assets. Traders cannot select which securities to include or exclude from the fund, leaving them at the mercy of the fund manager’s decisions. Therefore, if a particular stock performs poorly, traders cannot remove it from the ETF. If a trader wants to reduce their exposure to a specific asset, they must sell their entire ETF position.
Trading ETFs is also subject to corporate actions such as mergers or spin-offs initiated by the underlying companies. While these actions may not significantly impact short-term performance, they can affect long-term returns and leave traders with little control over their investments.
It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo Markets assumes no liability for any loss sustained from trading in accordance with a recommendation.
