Learning to Love ETFs

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The popularity of ETFs​ (exchange-traded funds) is showing no signs of slowing down. In fact, index funds—and predominantly index ETFs—are largely responsible for the shift from actively managed funds to passive index funds.

Here are three reasons why investors have embraced ETFs with such gusto:

1. Low management expenses

Although some ETFs are actively managed, the majority seek to track a specific index, like the S&P 500, by buying all or a representative sample of the stocks (or bonds) that are included in the index.

Because there are no fees being paid to a professional fund manager to hand-select specific stocks or bonds for the fund, the management expenses are inherently lower for an index fund compared with an actively managed fund. That means that index funds—ETFs and mutual funds alike—could be available at a fraction of the cost of a similar actively managed fund.

2. Built-in diversification

Just alike an index mutual fund, one index ETF could include hundreds—even thousands—of individual stocks or bonds in a single fund. This introduces a level of diversification that most investors couldn't achieve on their own buying individual stocks and bonds and that can ultimately help reduce overall investment risk.

And there's no shortage of options, with ETFs covering a wide variety of U.S. and international stock and bond markets. Some even focus on a specific industry, like energy or health care (although that increases the investment's risk). So whatever your desired asset allocation or investing style, there's probably an ETF for you.

3. Real-time pricing

One notable difference between ETFs and mutual funds, regardless of whether it's an actively managed fund or an index fund, is when they're priced—and when investors know that price.

An ETF's price will change throughout the trading day, meaning that the price at 10:30 a.m. could be different than the price at 2:30 p.m. And ETF investors can see that price in real-time so they have a general idea of the price before they place their trades.

But a mutual fund is priced just once per day—at the end of the trading day. So mutual fund investors don't know the price until after they place their trades.

Regardless of whether you choose an ETF vs. a mutual fund—or an actively managed fund vs. an index fund—there's one thing for certain: Before you buy any investment, always examine the fund's objective and investing style and understand how that fund fits into your asset allocation and overall investing goals.

 

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

All investing is subject to risk, including the possible loss of the money you invest.
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