Are You ETF Investor? Avoid These Four Common Mistakes When Investing In ETFs

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oi-Shubham Kumar

| Published: Saturday, July 30, 2022, 13:51 [IST]

ETF investing can offer a simple, affordable, and highly diversified option to build an investment portfolio. However, given how much attention ETFs have received, it’s understandable that errors are occurring when self-directed investors are putting their ETF portfolios into practice.

ETFs, offer access to the stock market at a reasonable cost. Since they are listed on an exchange and traded like stocks, they provide liquidity and real-time settlement. ETFs are a low-risk alternative because they mimic a stock index and provide diversification as opposed to investing in a small number of your preferred stocks.

ETFs, give you the freedom to trade anyway you want, whether you want to buy on margin or sell short. ETFs also give investors access to a variety of different investment opportunities, such as buying commodities and foreign securities. Options and futures, which are not available with mutual fund investment, can also be used to hedge your position.

However, ETFs are not suitable for all investors. As a result, several self-directed investors who are eager to use ETFs are making mistakes while investing in ETFs such as their investment fees, reducing their level of diversity, raising their level of risk, or lowering their long-term results. In this article, we are highlighting 4 common mistakes that you should avoid as an ETF Investor. These mistakes are as follows:

Holding Multiple ETFs

Holding a large number of ETFs is a typical mistake made while using them for investment. Three to four ETFs, at most, are needed to build a well-diversified ETF portfolio. When a portfolio has six, eight, ten, or twelve or more ETFs, there is likely potential for improvement. It’s simpler to manage a straightforward investing portfolio. Additionally, the likelihood of making behavioural investment errors is lower with a simple investment portfolio. When holding too many ETFs, the portfolio is more difficult to manage. The more complicated a portfolio is, the simpler it is to go off course and make irrational investing choices.

Investing in Sector-Specific ETFs

Another typical error made while investing with ETFs is the use of sector-specific ETFs. A sector-specific ETF isn’t necessary for the typical investor. A low-cost indexing strategy does not support investing only in one industry. Sector-specific ETFs are sometimes less diversified and charged greater fees. Sector-specific ETF investing is more speculative than broad-based index ETF investing. It’s crucial to understand that sector-specific ETFs are more speculative if your portfolio includes any. We advise limiting speculative investments to less than 5% of the whole portfolio as a best practice.

Leveraged ETFs

The typical investor SHOULD NOT use leveraged ETFs. The gains and losses of the underlying investments that leveraged ETFs track are amplified. A triple leveraged ETF, for instance, will increase a loss of 10% on the underlying investment to a loss of 30% on the leveraged ETF. Leveraged ETF holders should have very excellent reasons for doing so and should carefully weigh the increased risk they are taking.

Investing in ETFs having Duplicate Holdings

There is a significant risk of duplication when holding more than 3-4 ETFs or sector-specific ETFs. It may be intentional or inadvertent for the underlying investments to be duplicated, but using numerous ETFs to do so is frequently a mistake. Gains and losses in these assets will be amplified if you hold ETFs with similar or identical underlying investments. This duplication increases complexity, the concentration of investments, diversification, and risk.

Bottom Line

ETF investing can offer a simple, affordable, and highly diversified option to build an investment portfolio. However, it’s fair that investors make errors when putting their ETF portfolios into practice given the abundance of ETFs accessible. A simple, low-cost, yet highly diversified investment portfolio can be easily created by using a simple 3-4 fund ETF portfolio.

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Story first published: Saturday, July 30, 2022, 13:51 [IST]