After reading "Random Walk Down Wall Street" I become believer of investing into index funds. However, after trying it out for a couple of years I noticed some drawbacks in passive-index ETF (exchange traded fund) investing:
- Some ETFs do not replicate index by directly owning the stocks. They do this by swap-contracts. So you have got some level of counter-party risk (in case the other bank defaults and can't make good on the contract).
- Most ETFs are expensive (net fees and costs 0,5%-1% per year or more)
- Most ETFs have very big spreads (difference of buy/sell bid)
- This is typically tied to size of fund and daily volume of it.
- You have to trust the company running the fund
- Even if they claim that the assets are separate, I don't trust any banker 100%.
- Taxation of dividends
- Atleast in Finland, there is a difference in directly holding stocks and holding an ETF
- I get a 30% tax break on dividends from Finland and all countries with whom we have a tax contract. Essentially this means paying capital tax on 70% of received dividends.
Generally I think passive-index unleveraged ETFs are good if you can't diversify otherwise. Also, when investing outside your county and developed markets, it is probably a good idea to use ETFs. However, even with ETFs you need to think about diversification (across multiple funds and money management companies). Don't trust any one money management company too much!