ETFs offer diversification, low expense ratios (average 0.44%), tax efficiency, and access to global markets
Diversification
Asset Diversification
The main advantage of ETFs (Exchange Traded Funds) over individual stocks is that they are inherently diversified. Investing in an ETF is equivalent to buying multiple assets bundled in one package, which greatly reduces your investment risk. Instead of buying one tech stock (putting all your eggs in one basket), you can buy a tech ETF that has many of the same names (as of this writing: Apple, Microsoft, Google). That way, if one of the companies performs poorly, the impact on your investment is limited.
Larger Market Sector
With ETFs, investors can gain exposure to a wide range of industries without having to buy individual stocks. A classic example is investing in a healthcare ETF, which includes companies in the following industries: pharmaceuticals, medical devices, and biotech. Since your exposure is broad, it means that if one sector sees growth, your investment can take advantage of that performance. 2020 SectorXLV13.45%Health Care * Sector diversification can bring benefits.
Reduced Volatility
The value of a single stock can be very volatile, with price fluctuations affected by company performance, market sentiment, and other catalysts. Holding multiple stocks reduces the volatility of an ETF. Let’s say a stock might drop 10% in a day due to some bad news, while an ETF that owns 50 different stocks will only fluctuate 1-2%. The volatility of the S&P 500 ETF (SPY) is about 15%, while the volatility of the average stock is 20-30%.
Simplifies the investment process
Investing in ETFs makes the investment process easier due to diversification. Investors buy ETFs instead of researching and selecting a large number of individual stocks that they would need to hold to get close to the same level of diversification. By doing this, you not only save time but also reduce the complexity of overall portfolio management. For example, buying 20 different stocks can be a daunting task for new investors, but buying ETFs allows for immediate diversification of investments.
Cost Efficiency
Lower Expense Ratios
Since ETFs trade on exchanges like stocks, they generally have lower expense ratios than mutual funds and individual stock investments. Currently, the average expense ratio for ETFs is about 0.44%, while mutual funds can have expense ratios of 1.25% or more. This is important because it keeps more of your money invested and supporting you, rather than paying management fees. Hell, investing $10,000 into an ETF with an expense ratio of 0.44% will cost you $44 per year, while investing $10,000 into a mutual fund with an expense ratio of 1.25% will cost you $125 per year.
Lower Transaction Costs
Buying and selling a multinational stock incurs brokerage fees and commissions, which can quickly become very expensive, mostly for new traders. ETFs, on the other hand, generally have much lower transaction costs. Many brokers offer commission-free ETF trading, which means there are no additional buy or sell fees to pay for MTN ETF trading. For example, platforms like Robinhood or Fidelity offer commission-free ETF trading, allowing you to manage your portfolio for less money.
Tax Efficiency
However, ETFs tend to be more tax efficient than mutual funds. The reason for this is the unique structure of ETFs with in-kind redemption capabilities. ETFs can also deliver underlying securities to sellers instead of cash, allowing the fund to avoid capital gains distributions. In 2020, only 6% of ETFs distributed capital gains to investors, far less than the 53% of mutual funds, which means ETF investors also have less tax liability.
Economies of Scale
ETFs are beneficiaries of economies of scale, which reduces costs. As a fund’s asset base grows, the fixed costs of fund operations are spread over more assets, and for the same reason, the cost per investor should also fall. For example, the Vanguard Total Stock Market ETF (VTI) has more than $1 trillion in assets, so it only charges a fee of 0.5%. This efficiency of scale allows it to provide investors with quality investment management at a cost far lower than trading individual stocks.
Ease of Trading
Easy to Buy and Sell
Like individual stocks, ETFs are bought and sold on major stock exchanges, which means they can be bought and sold throughout the trading day. ETFs can be bought and sold at market prices throughout the trading day using a standard brokerage account. This mid-level ABMF offers the convenience of intraday trading, which is not available with mutual funds (which can only be bought and sold at the end of the trading day). You can also execute trades instantly with ETFs if you want to respond quickly to market news or you are looking for an opportunity.
No Minimum Investment Requirement
While mutual funds may require a four- to five-figure minimum investment, you can generally buy ETFs at a more affordable price. This means that more investors (including those who are newer or looking to invest less) can access them. Take the example of buying an ETF where you can only buy 1 share – this makes it possible to start investing evenly with only a small portion of capital. The average price of an ETF on most platforms is around $50-100, and ETFs from providers like Vanguard and iShares will be available to anyone with an account on those platforms by 2023.
Holdings Transparency
ETFs are disclosing their holdings more frequently. Unlike mutual funds, ETFs report their holdings on a daily basis. This openness allows investors to clearly understand what they own at all times, allowing them to make more informed decisions. For example, if you invest in an S&P 500 ETF, you can see a list of all the companies the fund holds, as well as their respective weightings, on the fund’s website.
Liquidity and Flexibility
ETFs have good liquidity because they are traded on the market and can therefore be easily bought and sold without causing large price changes. This can be particularly useful when the market is volatile, allowing investors to quickly enter and exit positions. For example, the SPDR S&P 500 ETF (SPY) trades tens of millions of shares per day, meaning there are usually willing buyers or sellers of the stock at any point in time. Additionally, ETFs can be used for a variety of trading and hedging strategies, including short selling, which is an attractive feature for many investors managing their portfolios.
Access to Various Markets
Global Investing
ETFs allow investors to easily tap into foreign markets. For example, to buy stocks in China and India or Europe and Japan, there are ETFs for each market. For example, the iShares MSCI Emerging Markets ETF (EEM) provides investors with exposure to companies in developing countries, while the Vanguard FTSE Europe ETF (VGK) provides exposure to large and mid-cap companies in Europe. With over 1,200 holdings through 2023, EEM helps mitigate the risk of any one region or sector dominating the investment case.
Investing in Specific Sectors
Sector ETFs Investors interested in identifying sectors of the economy can use sector ETFs. There are ETFs that focus on just about every sector you can think of – technology, healthcare, energy, real estate (you name it…it exists). This makes it a very useful tool to help people ensure their investments are aligned with certain aspects of the economy or a certain theme they want to invest in very precisely. For example, the Technology Select Sector SPDR Fund (XLK) invests in the largest tech companies like Apple, Microsoft, and Nvidia and will focus on their performance over time. XXXX is one of the best ETFs of 2022 with a gain of 34.5%, a reminder of the advantages of participating in specific industry investments.
Thematic and Niche Access
ETFs also provide access to themes and niches that may be difficult to invest in directly. These themes include clean energy, artificial intelligence, and blockchain technology, among others. For example, the Global X Robotics & Artificial Intelligence ETF (BOTZ) focuses on companies making advances in robotics and artificial intelligence technology, while the Invesco WilderHill Clean Energy ETF (PBW) targets companies in the clean energy sector. In 2021, PBW’s 52-week return of 61.1% reflects the strong interest and strong performance in the clean energy sector.
Commodities and Alternative Investments
One way investors can invest in commodities is through commodity ETFs (exchange-traded funds). Specialized ETFs allow investors to invest in gold, silver, oil, and even cryptocurrencies. For example, the SPDR Gold Shares ETF (GLD) is one of the best ways to invest in gold without actually owning it. With total assets under management exceeding $50 billion, it is one of the most widely held and liquid funds in the market.
