Building the best portfolios for investors requires smart thinking and planning. You want your dollars to work for you. Exchange-traded funds (ETFs) offer multiple ways to invest smartly in diversified funds at a lower cost.
What Are ETFS?
Exchange-traded funds are marketable securities that trade like common stocks and were first developed in 1993. Since then, ETFs have grown to encompass over $1.7 trillion in assets in just the United States alone.
ETFs can be tied to a variety of underlying assets ranging from stocks and bonds to oil futures, foreign currency, gold and more. Ownership of these assets is divided into shares. While shareholders do not own these assets directly, they earn a portion of profits in terms of dividends, earned interest and/or residual value when and if the ETF fund is liquidated. You can sell, transfer or buy an ETF stock just like you do other stocks available on public stock market exchanges.
ETFs offer access, flexibility, tax efficiency and low-cost indexing. ETFs can be a suitable addition to your portfolio when your investing goals range from saving for a home down payment or other large purchase to retirement. ETFs also offer a way to invest in globally diverse funds affordably. (For related reading, see: The Main Attraction of ETF Investing.)
Below are five benefits of having ETFs in your investment portfolio:
- Technical Sophistication
- Tax Efficiency
ETFs Offer Flexibility
ETFs are accessible. Anyone with a brokerage account and money to afford even one share or partial share (fractional share) can buy ETFs. They provide tremendous flexibility and are versatile investment tools for both short-term and long-term investing.
ETFs Can Be More Affordable
ETFs are lower cost with pricing that matches the price of underlying assets. A lot of ETFs are index funds but do not have additional fees. ETF costs include licensing from data publishers, administrative fees such as exchanges, trusts and lawyers, and manager compensation in one fee called the expense ratio. When compared to mutual funds that have additional fees for active management through distribution agreements via financial advisors and brokerage systems, ETFs are significantly less expensive. ETFs eliminate the middle men. As an individual investor, you can purchase stock and bond index ETFs at significantly lower prices than you would pay for the equivalent in index mutual funds.
ETFs Are Naturally Diversified
ETFs are by nature diversified and follow the Investment Company Act of 1940 that requires diversification without too much concentration in any one specific company or industry sector. This prevents overexposure to any individual stock, bond, industry or country and lowers risk.
Technical Sophistication Keeps ETF Trading on Par
ETFs benefit from technical sophistication, building upon the progress of technology tools used in the purchase and sale of securities over the last 50 years. ETFs are measured precisely using specific and varied data points that investors analyze and watch constantly throughout the day. This combined effort ensures that ETF trading stays on par with underlying assets.
Benefit From ETF Tax-Efficiency
ETFs operate with tax efficiency. ETFs are similar to index funds that do not create internal capital gains from frequent movement of stock and bond sales by investors and management, known as churning. ETF shares can only be issued or redeemed at the end of the day since they are mutual funds.
(For more from this author, see: 10 Common Investing Questions Answered.)