Correct. The advantage is that you can access more data than is on your computer’s hard drive, but the downside is that the files which are not local are not backed up.
I have a Mac Mini that downloads all of my iCloud and Dropbox files, and that computer backs them up, but for my MacBook Air, even with a 1TB drive, there’s not enough room for all of my Dropbox and iCloud files to remain locally (unless you want to tape a drive to the back of your laptop screen, of course).