It can be difficult to decide where to put your money. There is no such thing as a “perfect” investment. But are ETFs the best way to invest? In recent years ETFs have grown in popularity due to their ease of diversification. So much so that they now hold trillions of dollars in assets, and remain a great option for those looking to dip their toe into the stock market.
EFTs are the best way for people who are looking to diversify their investment portfolio to invest. EFTs are a great investment for beginners who don’t have time to do extensive research about a potential investment. EFTs are generally low risk and low reward, although some are higher risk.
Like any investment, ETFs have advantages and disadvantages. It is important to understand them before investing your money in this popular type of fund. So, are ETFs the best way to invest?
What Are ETFs?
We discuss this in more detail when answering Are ETFs Safer Than Stocks?
For a very brief recap:
ETF stands for Exchange-Traded Funds.
ETFs are a group of investments of stocks or bonds that can be bought and sold easily, like stocks. The ETF is a portfolio that a professional money manager puts together and offers to investors.
ETFs were initially introduced to the market in the 90s, but have now become a popular choice for investors who want to avoid mutual funds.
ETFs allow investors to put their money in multiple stocks, bonds, and securities at once (which is also known as diversification). Diversification reduces the inherent risk posed to investors.
Some ETFs invest in a variety of stocks and bonds, others recreate the performance of a stock index, and others track a particular market. An investor will earn a return from an increasing ETF market price and dividends.
Types Of ETF
There are many different types of ETFs, but the following are the most common.
Stock ETFs aim at long-term growth and they tend to be lower risk than individual stocks.
Commodity ETFs permit the investor to take multiple securities of raw goods and put them into a single investment. It is important to note the tax implications of these types of ETFs as they may be considered “collectibles” to the IRS.
Bond ETFs typically generate cash payments for the investor because the bond is made up of individual bonds that accumulate interest. These are generally lower risk than stock ETFs but often result in a low payout.
International ETFs can be purchased in individual countries and allow people to invest in a foreign stock without high risks. They help investors diversify their portfolios.
Sector ETFs let investors put their money in a particular company or industry that intrigues them. These carry a slightly higher risk than broad market ETFs.
Benefits Of ETFs
ETFs have a very high level of diversification. Diversification means that you can spread out investments into a variety of assets. Diversification is important when it comes to investing because it decreases the amount of risk the investor is exposed to.
Although risk cannot be eliminated in any type of investment, ETFs offer a good balance of risk and return.
Diversification also means that an investor can be involved in multiple industries without much money or effort being used.
Generally, ETFs have lower fees and higher liquidity than mutual funds, so they can be sold and purchased with ease. This is beneficial to investors who want to be able to access their investment when cash is needed without hassle.
ETFs can be tailored to match specific goals. There are a variety of thematic ETFs available that allow investors to invest based on a theme such as climate change, artificial intelligence, or beauty products. If an investor sees a trend or potential in a particular area, they can target their investment into a section of that industry.
ETFs save the investor research time. Many investors simply don’t have the time or knowledge to check the stock market often and research each company they want to invest in carefully. They also give the investor the unique ability to participate in a wide market with just one purchase. ETFs also have a lower minimum investment and lower management fees than mutual funds.
Most ETFs do not have a minimum share investment other than the share price, which attracts investors who don’t have or want to invest a large sum upfront.
Disadvantages To ETFs
ETFs may have trading fees.
Because ETFs are traded like stocks, each transaction charges commission. Exchange-traded funds can make investors susceptible to the underlying fluctuation of the market. Depending on the scope of the fund, there is a potential for dramatic changes.
ETFs typically produce lower dividend yields for investors, which can be a drawback as well. Higher growth and value are generally found in individual stocks, so this may drive away investors.
Investors who are not satisfied with average returns might not want to consider ETFs. ETFs are a combination of winning and losing stocks. When these wins and losses are combined, investors end up with average returns.
For this reason, more experienced investors who are confident in their ability to pick stocks typically stay away from ETFs.
Due to the COVID-19 pandemic, 2021 was an unpredictable year in the stock market. In 2022, experts expect investors to avoid large-cap (companies with a capitalization value of more than 10 billion dollars, or more stable and popular stocks). They also expect exchange-traded funds to continue to multiply greatly.
The following table shows the ETFs that have accrued the most assets in 2022. You may want to consider investing in them:
|Fund||Net Flows in USD Millions (source)|
|iShares Core S&P 500 ETF||4,083.34|
|iShares MSCI Kokusai ETF||3,667.25|
|Vanguard S&P 500 ETF||2,824.21|
|iShares Core Total USD Bond Market ETF||1,671.80|
|iShares Core MSCI EAFE ETF||1,199.21|
|Financial Select Sector SPDR Fund||963.38|
|SPDR S&P Biotech ETF||813.25|
|SPDR Bloomberg 1-3 Month T-Bill ETF||790.77|
|iShares 10+ Year Investment Grade Corporate Bond ETF||775.91|
|iShares MSCI ACWI ETF||768.54|
So, Are ETFs The Best Way To Invest?
Investing your money in the right place can be a daunting task.
ETFs are a great opportunity for novice investors to begin exploring their options. For them, ETFs might be the best way to invest.
However, consult a financial advisor who knows your financial profile and goals before you start.
For the experienced stock market investor, ETF’s are probably not your best bet.
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