Exchange traded funds (ETFs) have a number of features that can make these investment vehicles ideal for young investors with small amounts of capital to invest. For one, exchange traded funds make it possible to build a diversified portfolio with relatively low investment amounts. In addition, ETFs trade throughout the day, providing ample liquidity, and many have relatively low-cost structures. In fact, there are at least five reasons why young investors might want to consider ETFs for potential investment opportunities.
1. Variety of ETFs
The first ETFs, which were introduced in the late 1980s and early 1990s, were relatively plain-vanilla products that tracked equity indexes such as the Standard & Poor's 500 Index and the Dow Jones Industrial Average. Since then, the range of available ETFs has exploded to include practically every asset class—stocks, bonds, real estate, commodities, currencies, and international investments—along with any sector imaginable and many niche areas, as well.
- Exchange traded funds can offer opportunities for young investors with relatively small amounts of capital to invest.
- With more than 1,800 to choose from, exchange traded funds can be used to participate in a wide variety of different markets.
- ETFs can be bought and sold throughout the trading day and many are highly liquid with substantial trading activity.
- Most exchange traded funds use a low-cost indexing approach.
- Some ETFs capitalize on fads or trends, such as building portfolios based on environmentally or socially responsible investing.
Competition among ETF issuers has resulted in the introduction of ETFs that are very specific in focus, so young investors can find specific ETFs that track particular markets or segments that may be particularly appealing to them. There are also a number of inverse ETFs, which trade in the opposite direction to an asset or market, and leveraged ETFs that magnify results by two or three times.
As of early 2020, there are more than 2,000 U.S.-based exchange traded funds, according to data from research and consultancy firm ETFGI. For young investors, this extensive range of available ETFs offers a wide variety of investment choices.
The range of ETFs also means that an investor can build a diversified portfolio with a lower outlay of capital than would have been required in the past. Consider the case of a young investor with $2,500 to invest. Let's assume that this investor is a keen student of financial markets and has some well-defined views on specific investments. They are optimistic about the U.S. equity market and would like exposure to U.S. stocks to be their core investment position, but would also like to take smaller positions to express two other views: bullish on gold and the Japanese yen, expecting both to move higher.
While such a portfolio would have required a much higher outlay of capital in the past (especially before the advent of commodity and currency ETFs), the investor with $2,500 can build a portfolio incorporating all views through the use of ETFs. For example, this investor could invest $1,500 into the Standard & Poor's Depositary Receipts 500 Trust (SPY), and invest $500 in both the SPDR Gold Fund (GLD) and the Invesco CurrencyShares Japanese Yen Trust (FXY).
2. Liquidity of ETFs
The fact that most ETFs are very liquid and can be traded throughout the day is a major advantage over index mutual funds, which are priced only at the end of the business day. This becomes an especially critical differentiating factor for the young investor, who may want to exit a losing investment immediately in order to preserve limited capital. Ample liquidity also means that investors have the ability to use ETF shares for intraday trading, similar to stocks.
3. Low Fees of ETFs
Exchange traded funds generally have lower expense ratios than mutual funds. Additionally, although they are bought and sold like stocks, many online brokers offer commission-free ETFs, even for investors with small accounts. This can be a big help to young investors, as high fees and commissions could really put a dent in their account balance.
4. Investment Management Choice with ETFs
ETFs enable investors to manage their investments in the style of their choice: passive, active, or somewhere in between. Passive management, or index investing, simply involves building a portfolio to mimic one or more market indexes, while active management entails a more hands-on approach and the selection of specific stocks or sectors in a bid to "beat the market."
Young investors who are not altogether familiar with the intricacies of the financial markets would be well-served by using a passive management approach initially and gradually moving to a more active style as their investing knowledge increases. Sector ETFs enable investors to take bullish or bearish positions in specific sectors or markets, while inverse ETFs and leveraged ETFs make it possible to incorporate advanced portfolio management strategies.
5. Keeping Up with Trends via ETFs
One of the principal reasons for the rapid growth of ETFs is that their issuers have been at the leading edge in terms of introducing new and innovative products. ETF issuers have generally responded rapidly to demand for products in hot sectors. For example, numerous commodity ETFs were introduced during the commodity boom of 2003-07. Some of these ETFs tracked broad commodity baskets, while others tracked specific commodities such as crude oil and gold. A number of ETFs adhering to environmental, social, and governance (ESG) investing principles have been launched as well.
Though the majority of ETFs are passively managed, just tracking an index, actively managed ETFs do exist.
The dynamism and innovation displayed by ETF issuers is another feature that is likely to appeal to young investors. As new investment trends get underway and demand surfaces for even newer investment products, there will undoubtedly be ETFs introduced to meet this demand.
The Bottom Line
Young investors who are not altogether familiar with the intricacies of the financial markets might be well-served by investing in an exchange traded fund that tracks the broader market. Sector funds enable investors to take bullish or bearish positions in specific sectors, while inverse ETFs and leveraged ETFs make it possible to incorporate advanced portfolio management strategies. Some other characteristics of ETFs that make them ideal investment vehicles for young investors include diversification, liquidity, low fees, investment management choice, and innovation.