Even as the exchange-traded fund (ETF) industry has seen dramatic growth in recent years, most of these investment vehicles still fall into one of two large categories: value and growth. In a nutshell, value ETFs are those focused on companies that are believed to be undervalued according to traditional valuation metrics. Growth ETFs, on the other hand, look toward companies that are growing at a more rapid clip, even if they may also experience higher volatility. A report by ETF.com indicates that growth ETFs have been particularly strong in the first part of 2018. However, some market analysts believe that value ETFs may soon catch up. Read on to learn about some of the trade-offs and benefits to each of these two categories of ETF.
Risk Tolerance Is Key
One of the most important considerations to keep in mind when preparing for an ETF investment is your personal level of risk tolerance. Many investors take on both value and growth ETFs as part of a balanced, diversified portfolio. Value ETFs tend to appeal to more conservative investors who would rather not suffer through periodic market fluctuations. On the other hand, investors who don't mind a larger degree of volatility in the face of potentially above-average returns might wish to focus their efforts on growth ETFs. In both cases, it's common for a portfolio to include some of each of these types of funds; the consideration of risk tolerance has an impact on the relative weight of each. (See also: Value vs. Growth ETFs: How Do You Choose?)
Investment Goals and Time
Another key factor in weighing the trade-offs between value and growth ETFs is your time horizon. The longer that your money will be invested, the higher your risk tolerance tends to be, and the larger your emphasis on growth ETFs relative to value. Taking the long view on your investments, in these cases, allows you to tolerate shorter-term market fluctuations. (For more, see: Using Time Horizons in Investing.)
Benefits of a Value ETF
A value ETF may be a good option for an investor new to the ETF space. Many value ETFs focus on popular companies that are seen as broadly stable. ETFs made up of so-called value stocks might include those of big-name brands like The Coca-Cola Company (KO) or The Procter & Gamble Company (PG), for instance. Many of these companies aim for more conservative long-term growth figures in exchange for a lower degree of volatility.
A major benefit of including value ETFs in an investment portfolio is the dividend yields of these companies. With value stocks often drawing larger cash flow, it's common for cash flow to be paid out as dividends. These dividends can help to increase shareholder return for ETF investors. (See also: Top 5 Value ETFs of 2018.)
Benefits of a Growth ETF
For many investors, growth ETFs do not make up the core portion of a portfolio but rather act as a complement to other investments. Growth stocks like the FAANG companies, for instance, have become highly popular in ETF baskets. Many growth stocks represented in these funds offer the opportunity for excellent return on investment. However, with the prospect of stellar returns also comes the risk associated with volatility. Oftentimes, growth stocks and the ETFs relying on them struggle during times in which the broader economy is not doing well.
One important consideration to keep in mind is that growth ETFs will not likely provide regular income. The reason for this is that a good number of growth-focused companies tend to reinvest any available cash into expanding the business rather than paying out profits to shareholders. Don't expect much by way of dividends from these companies. (For more, see: Top 3 Growth ETFs for 2018.)
The Bottom Line
Regardless of whether you choose to focus on growth or value ETFs, it's crucial to learn as much as you can about any of these funds before investing. Determine the ETF's approach and focus, and learn about the stocks that the ETF invests in and the ways that it is managed. Always consider the expense ratio of the fund before making an investment. With careful consideration and deliberate investment decisions, it's possible to benefit from the tremendous growth of ETFs in recent years. (For additional reading, check out: Value or Growth Stocks: Which Are Better?)