Exchange-Traded Funds (ETFs) are one of the most popular ways to invest in financial markets today. But what are they exactly? Think of ETFs as a basket of securities: they’re essentially a pre-selected collection of securities, typically stocks and bonds, all wrapped up in one fund.
Their name also gives away how they work: “exchange-traded” means these funds are bought and sold on an exchange just like stocks, and you can trade them during normal trading hours. If you want to invest in an ETF you basically go about it the same way you would with buying a security like a stock, and purchase them through a broker or brokerage account.
Given all these features, ETFs can be a worthwhile addition to a portfolio. They could save you a lot on fees (compared to buying all of the securities in an ETF individually) and help you diversify your portfolio. And that’s just the beginning!
Here are four reasons why ETFs may be worth considering for your investment portfolio.
Remember that “basket of securities” concept we mentioned earlier? With ETFs, you don’t have to pick individual stocks or bonds — when you own shares of an ETF, you own a stake in a fund that may hold hundreds or even thousands of individual stocks or bonds.
There are many different kinds of ETFs, too: you could invest in an ETF that only includes bonds, one that’s a mix of stocks and bonds, one that tracks a particular industry, or even European-focused ETFs. Many ETFs also aim to track the performance of an index like the S&P 500, meaning they try to match the returns of that market or subset of the market.
ETFs can give investors access to a range of different assets, and you could also mix and match ETFs that encompass different types of securities or industries to diversify your portfolio even more!
All this is to say that the diverse makeup of ETFs is like a built-in way to help hedge your bets – if one or two securities go down in value, you have the remaining securities in the ETF to help cushion any losses. Keep in mind that ETFs aren’t risk-proof — no investment is! — but they could carry less risk compared to investing in a single company.
If you’ve bought or sold stocks before, you know that you often pay fees each time you make a transaction — and those fees can add up quickly if you’re purchasing a bunch of securities individually. With ETFs, though, there’s only one transaction you pay fees on and you get access to an entire collection of assets at once.
Good to know: You’ll still likely have to pay a managment fee, but most ETFs generally have lower annual expenses than mutual funds. In fact, the average equity ETF charges just 0.53% in annual expenses, compared to the average U.S. equity mutual fund which charges 1.42%.
Like mutual funds, ETFs can give you a diverse basket of assets. But ETFs come with an added bonus: unlike mutual funds which only trade at the end of the day, ETFs can be traded the same way as traditional stocks and commodities on the stock market.
Since ETFs are traded during normal hours on the stock market and exchange hands hundreds of times each day, investors can jump in and out at will, just like they might with buying and selling stocks.
ETFs are sometimes referred to as “tax-friendly” investments. While that’s not to say you won’t pay taxes on your ETF capital gains – the profit you make off a sale of a capital asset that’s typically considered taxable income – ETFs come with two major tax advantages, at least compared to actively managed mutual funds.
Because of how they are each set up, ETFs can incur fewer capital gains taxes and lower long-term capital gains rates than actively managed mutual funds. With ETFs, you also won’t have to pay taxes on your capital gains until you sell the assets. With actively managed mutual funds, investors will pay capital gains taxes while holding the securities, because managers will liquidate and purchase investments in an effort to beat the market.
Hopefully going over some of the features of ETFs has given you an idea of how they could potentially work for your investing goals. In a way, ETFs are like a combination of a stock and a mutual fund: they can provide similar diversity of a mutual fund but with the same ease of trading as stocks. On top of that, ETFs are often an easy way to diversify your portfolio, typically with less work and lower costs than buying stocks or bonds individually.
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