Apparently nothing can ever be simple on Wall Street. Take the case of a simple question like "should I invest in ETFs?" A beginning investor can spend less than 10 minutes on Google (Nasdaq:GOOG) and learn (if that is the right word to use) that exchange traded funds (ETFs) are the greatest invention since fire, the worst thing since the Yugo, or "investing in ETFs involves risks and may or may not be appropriate for your individual situation, please consult an advisor". (For a background, see our Introduction To Exchange-Traded Funds.)

While it is true that everybody's financial situation is different, here are some advantages of ETFs - relative to stocks and mutual funds - for beginners to consider.

IN PICTURES: 10 Reasons To Add ETFs To Your Portfolio

Less Due Diligence
The iShares US Medical Devices ETF (NYSE:IHI) contains 40 different stocks. It would take weeks for an individual investor to do proper due diligence on each of those names, and that is one of the advantages of ETF investing. Because the impact and importance of any one stock is relatively small, investors can spend their time thinking about which sectors and markets are poised to perform and make investment choices without being bogged down by an overwhelming amount of initial and ongoing due diligence.

Might Be Cheaper
Whether you compare them to mutual funds or individual stocks, ETFs can be cheaper to own and trade. Many major brokerages now offer a selection of ETFs that investors can trade commission-free, and that gives them a cost advantage relative to individual stocks. Many ETFs, particularly index-type ETFs, have lower annual expenses than comparable mutual funds and can be cheaper to hold.

No Minimums
While it is possible to find quality mutual funds with low minimum initial investment requirements, ETFs have no such requirements at all. If an investor has $100 to invest and has an account with a broker that offers free ETFs, it is possible to put that money to work immediately. Likewise, there are no minimums for subsequent investments and no minimum "maintenance" amounts.

IN PICTURES: 10 Tips For The Successful Long-Term Investor

Instant Diversification
ETFs provide instant diversification relative to individual stocks. It would be challenging to have a properly diversified portfolio with 10 individual stocks, but relatively simple with the same number of ETFs. (To learn more, see 10 Ways ETFs Can Grow Your Portfolio.)

Invest In Hard-to-access Markets
Owning gold is a pain for most individual investors; owning SPDR Gold Shares (NYSE:GLD) (which owns gold bullion) is simple. Not only does this ETF bypass the bid-ask spreads of retail gold and the expense of rolling over futures contracts, but it has no storage or security requirements. Likewise, investors can access commodities like copper, precious metals, timberland and so on through the convenient forms of ETFs. (For more, check out Commodities: The Portfolio Hedge.)

Can Buy Insurance
Because they are for all intents and purposes stocks, ETFs offer more sophisticated options for experienced investors – particularly when it comes to insurance. If you own the S&P 500 SPDR (NYSE:SPY) - an ETF that mimics the S&P 500) - you have broad exposure to the U.S. stock market. If you are worried about a decline in the market, though, you can also buy put option contracts to cover some or all of that exposure. This helps ensure your position against loss, though at a cost - just like insurance. This strategy is not really an option with mutual funds.

Can Pair-trade
Pair-trading is only for sophisticated investors, but it is another strategy that ETFs can enable. Pair trading involves buying one security and shorting a similar security, for instance buying a stock like Merck (NYSE:MRK) and simultaneously shorting Pfizer (NYSE:PFE). The idea is to profit from the relative difference in fortunes between the two companies, but investors can use ETFs to pair-trade by buying or shorting "the industry" and taking an opposite position in a particular company that the investor believes will do better/worse than the industry. (To learn more, see Give ETF Pairs Trades A Chance.)

The Bottom Line
There is no such thing as a perfect investment, so investors need to accept that any idea will have its flaws and drawbacks. Still, ETFs do stand apart as an investment category with some real positives for individual investors. As a cost-effective way of achieving a broadly-diversified portfolio including hard-to-own (but worthwhile) assets, ETFs are hard to beat. Accordingly, almost any investor may find that ETFs can play a useful role whether in place of or amidst a portfolio of stocks and bonds. (For more, see How To Use ETFs In Your Portfolio.)

Use the Investopedia Stock Simulator to trade the ETFs mentioned in this article, risk free!

For the latest financial news, see Water Cooler Finance: Rising Markets And Buffett's Successor.

Related Articles
  1. Mutual Funds & ETFs

    A Guide to Mutual Funds Trading Rules

    Make sure to review this guide on the dos and don'ts of mutual fund trading before you invest, including how trades are executed and which fees to look out for.
  2. Economics

    India: Why it Might Pay to Be Bullish Right Now

    Many investors are bullish on India for all the right reasons. Does it present an investing opportunity?
  3. Mutual Funds & ETFs

    Top 3 PIMCO Funds for Retirement Diversification in 2016

    Explore analyses of the top three PIMCO funds for 2016 and learn how these funds can be used to create a diversified retirement portfolio.
  4. Mutual Funds & ETFs

    The 4 Best Lord Abbett Mutual Funds

    Discover the four best mutual funds administered and managed by Lord, Abbett & Co., LLC that offer investors a wide variety of investment strategies.
  5. Mutual Funds & ETFs

    The ABCs of Mutual Fund Classes

    There are three main mutual fund classes, and each charges fees in a different way.
  6. Investing Basics

    10 Habits Of Successful Real Estate Investors

    Enjoying long-term success in real estate investing requires certain habits. Here are 10 that effective real estate investors share.
  7. Investing Basics

    5 Types of REITs And How To Invest In Them

    Real estate investment trusts are historically one of the best-performing asset classes around. There are many types of REITs available.
  8. Investing Basics

    5 Simple Ways To Invest In Real Estate

    There are many ways to invest in real estate. Here are five of the most popular.
  9. Investing Basics

    5 Common Mistakes Young Investors Make

    Missteps are common whenever you’re learning something new. But in investing, missteps can have serious financial consequences.
  10. Mutual Funds & ETFs

    The 4 Best American Funds for Growth Investors in 2016

    Discover four excellent growth funds from American Funds, one of the country's premier mutual fund families with a history of consistent returns.
RELATED FAQS
  1. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  2. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  3. Can hedge fund returns be replicated?

    You can replicate hedge fund returns to a degree but not perfectly. Most replication strategies underperform hedge funds ... Read Full Answer >>
  4. Does mutual fund manager tenure matter?

    Mutual fund investors have numerous items to consider when selecting a fund, including investment style, sector focus, operating ... Read Full Answer >>
  5. Do ETFs pay capital gains?

    Exchange-traded funds (ETFs) can generate capital gains that are transferred to shareholders, typically once a year, triggering ... Read Full Answer >>
  6. How do real estate hedge funds work?

    A hedge fund is a type of investment vehicle and business structure that aggregates capital from multiple investors and invests ... Read Full Answer >>
Hot Definitions
  1. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  2. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  3. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  4. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  5. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
Trading Center