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ETFs
What Benefits Do ETFs Offer to Investors?
by InvestorGuide Staff (Write for us!)
(Click on the links within the article to get definition of that word)
What seems to confuse most investors about Exchange-Traded Mutual Funds, or
ETFs, is that they seem to be mutual
funds - but aren't. Investors like mutual funds because they spreadrisk by diversifying investments.
However, most do not like the management and operating expenses associated with actively managed mutual funds.
That is why index funds (designed to track the major indexes such as the S&P 500 or NASDAQ) have become so popular
- they may not be actively managed but their returns are in-line with the benchmarks they were designed to mirror.
Similarly, ETFs are not actively managed but they are designed to mirror other indexes and offer a number
of significant advantages to investors.
One problem that many investors have with mutual or index funds is that they tend to just sit in a
portfolio - for years. There is nothing wrong with long-term investments but they cannot be used to take advantage
of short-termmovements in the market. For instance, record oil prices were set in 2005 due to Hurricane Katrina.
If an investor were to want to take advantage of the expected upturn in crude prices via mutual funds, they would
have to wait until the end of the business day when the netassetvalue (NAV) is calculated.
Then, on the next businessday, the investor could then buyshares in a mutual
fund with oil company holdings -
and the value of that mutual fund would remain the same until its value was calculated again that evening.
Basically, the price could fall again before the investor even was able to sell - and then there would be penalties
and possibly salescommissions to pay.
Mutual funds are not investments tools for those looking to speculate on short term price movements.
However, what if a number of tech companies made a recent round of earnings reports and the news was all good -
even better than expected? It would seem that any index mirroring the NASDAQ would probably do quite well in the
next day or two - right? With an ETF that tracked the NASDAQ, an investor could buy shares early on and then sell
them later for a profit - because ETFs trade like stocks.
ETFs are not indexes but they were created to mirror them while trading like stocks. Investors must pay commissions
for all trades just like for stocks but the ETFs are designed to be as diversified as the original indexes that
they mirror. This provides the investor with a lot more flexibility along with the added benefit of reduced
risk thanks to diversification.
One of the big sellingpoints for ETFs is that they are much cheaper than actively managed mutual funds and
less expensive than index funds. Most investors love ETFs and their lowexpense
ratios because it means they have
more money to actually invest. One of the big complaints about mutual funds is that management, operatingfees,
and even commissions are all taken out before any shares are even purchased. Although these same fees may lower
turnover, they also reduce the amount of capital actually used to invest.
Index funds are less expensive than mutual funds because they are not actively managed so there are no management
fees to worry about. But, ETFs have even lower expenseratios than index funds, as the averageexpense ratio for
an ETF is between 0.1-0.7%. There are, however, commissions with every ETF trade but even these expenses can be
minimized by finding brokerages with flat commissions in the $10-15 range.
Another of the major benefits of ETFs is their ability to help investors diversify their portfolio. Asset allocation
is an important part of any investment strategy. No investor should put all of their "eggs in one basket"
which is why most financial advisors recommend splitting portfolio assets between equities, bonds, cash, and
real estate. Depending on the amount of risk an investor is willing to take; different proportions of money
will be invested into each asset class. Younger investors tend to take more risks and may have a portfolio
with 80% of assets devoted to equities and 20% to fixed-income bonds. As
the investor progresses, more asset
classes will be added to the portfolio and risks will be spread even further. ETFs allow investors the ability
to quickly diversify their portfolio with minimal expense.
There are ETFs to cover every major index, asset class, and niche an investor can imagine. There are ETFs made up
exclusively of specialty industries in the tech and energysectors. Commodities such as gold and oil are
also covered by ETFs. Investors can even add realestate investments to their portfolio buy purchasing a
niche ETF in the REIT market. An entire portfolio of diversified investments can be created quickly and
simply by using ETFs.
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