If you’re an investor, you’re probably holding one or more Exchange Traded Funds (ETF) in your portfolio. ETFs trading has become a stock market staple in the past few decades. Let’s delve deeper into ETF portfolio management, how they work, the pros, and the risks, suitable platforms to trade them and how much you should be investing in ETFs.
ETFs – Introduction
The Exchange Traded Fund has observed a 50 percent rise in just five years. According to the recent market statistics, there were around 2,143 ETFs in the U.S. Well, there is an obvious reason for this popularity. As ETFs depend on indexes, it’s a great approach for both independent and the institutional traders to invest in the futures market.
The major difference between ETFs and mutual funds is that the former is built to match a particular market index while the latter deals with particular stocks with the hope of surpassing the general market.
How does it work?
An ETF involves a wide range of instruments including stocks, bonds, and other securities. Through investing in a single ETF share, the trader gets hold of this diversified investment portfolio. ETFs are built using an index approach and this is why their value changes in accordance with the index they track.
Purchasing an ETF share is simple, quick and economical for investors to keep a share of that basic portfolio, and make money from the price changes.
ETF – Types
Versatility is certainly the biggest perk that comes handy with ETF trading. The best bit? They can be adjusted to match almost any investment goal. Some of the most common ETF types include:
Index Funds: Index funds are ETFs that invest in expansive markets. When you purchase one of these funds, what you get is a small segment of every company stock involved in that index. Typical examples include VFINX and SWPPX.
ETNs: ETNs are often referred to as the ETFs’ sibling the purpose of which is to invest in bank-issued debt securities. They are primarily used to generate income and build high-interest security portfolios that might not be accessible to small investors.
Commodity ETFs: This ETFs type deals with the investment of particular natural resources like gold, oil, etc. SPDR Gold Shares a.k.a. GLD is one of the best examples which is believed to be the most popular gold ETFs presently available in the world.
Sector ETFs: ETFs can also be used to invest in sector-based indexes like power or healthcare. In addition to that, investors can also invest in specific industries and developing markets.
Inverse ETFs: Inverse ETFs allows traders to make money from downturns in the underlying market.
ETFs – Pros
Cost-Effectiveness: ETFs are comparatively inexpensive to buy and sell.
Low Expense Ratio: Unlike other alternates, the rate of expense associated with ETFs is substantially low.
Effortless Trading: You don’t need any specialized training to invest in ETFs. They can be traded like simple stocks.
No Minimum Requirement: When it comes to ETFs, there is no hard and fast rule for the minimums. In fact, they can be bought in any denomination.
Simplicity: With ETFs, even a small investor can make money from a diversified portfolio of shares and that too with some basic investment.
Balanced Portfolio: You can build a diversified portfolio by investing in just a few ETFs. For instance, you can diversify your portfolio by investing in bonds, developed as well as emerging stocks or S&P 500.
Tax Relaxation: Since ETFs don’t focus on component stocks that much, they generally don’t produce taxable gains.
Speed: This is certainly the biggest advantage. Unlike mutual funds, ETFs can be settled on the same day of buying or selling them.
Wide Range of Options: A wide range of profitable assets can be used in line with ETFs which give investors a great opportunity to diversify their investments.
Although the list of advantages associated with ETFs is far bigger than its cons, it’s still important that you keep these risks in mind while trading with ETFs:
You Cannot Surpass the Market: While this may be a benefit for many traders especially for those who are happy to match the current market situations, you cannot think about outperforming the general market even if you’re willing to invest many years to achieve this.
Chances of Loss: Since ETFs are linked with the underlying market conditions, their values assuredly decline with market fluctuations.
ETFs Aren’t Risk-Free: The general misconception about ETFs is that they are risk-free. There is no denying the fact that they can better handle risk as compared to stocks and mutual funds, but as ETFs track the general market, they tend to fall more often than the typical market securities.
ETFs – How much should you invest?
How much you should invest in ETFs entirely depends on your level of investment. For example, if you’re a small or a medium-scale investor, it would be great if you invest more and more in ETFs. However, if you possess a self-driven account, then you need to follow different strategies to build your portfolio.
Ideally, around 50% of your investment portfolio could be covered by ETFs involving the below-mentioned types of assets:
U.S. stocks or bonds
International emerging or developed market stocks
Contingent upon your investment choices, you can also diversify your portfolio based on different sectors. For instance, you can include ETFs for high-yield bonds, any particular industry sectors such as power or healthcare or even add ETFs for the emerging industries.
There are many reasons why ETFs have become a prominent investment choice than other securities like stocks or mutual funds. Their basic advantage over other securities, obviously, is that they let the trader invest in a variety of assets. Also, ETFs are better than mutual funds because they’re more flexible as they can be bought or sold on the stock market. Interested investors can trade ETF shares throughout the day. In addition to that, traders can also increase their chances of success by making use of diversified stock strategies. For instance, selecting margin buying and investing in just a few numbers of shares.
ETFs not only provide investors with an opportunity to take benefit from broadest market exposure, but it also helps to lower down the risk in a variety of different ways.
ETFs may have introduced back in the 1990s, but they’re definitely one of the most popular investment trends of the present-day investment world. If you haven’t given this trend a try, it’s high time you should invest in ETFs to diversify your investment portfolio.
(Featured image by DepositPhotos)
DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation for writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.
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