Whether you’ve used them for years or you’ve only discovered them recently, ETFs are becoming an increasingly popular tool for both new and experienced investors. Offering a wide range of benefits when compared to more traditional instruments, ETFs are forming part of the basis of a new generation of wealth managers.
At Moneyfarm, we use carefully selected ETFs to add further diversification to our portfolios, but what are they?
ETF stands for exchange-traded fund – a type of investment fund with two key characteristics:
- It is traded like a share on the stock market
- It exists primarily to passively replicate its benchmark index. This means that an ETF contains a pool of securities aimed at seeing the same returns of a given index. Unlike speculative trading, the objective is not to outperform the market.
But what makes ETFs an increasingly sought-after solution for investors? Here are seven reasons why you should consider ETFs as a fundamental part of your portfolio.
Controlling risk
Most investors use ETFs as a tool for effective diversification. By investing in a pool of assets, using ETFs eliminates certain risks while offering exposure to a variety of commodities.
This is the clearest advantage of an ETF over other traditional investment tools. Essentially, through diversification, the investor takes on less risk as they are not bound to the fortunes of a single company or asset. Losses in one area of the fund can be offset by gains in others, a fundamental tenet of smart investing that ETFs are uniquely equipped to support.
Simplicity
Despite the complexity of the funds themselves, investing in ETFs is simple. Any good wealth manager will make them a big part of their investment strategy, so it is often as straightforward as choosing the right one.
Diversification is the clear aim for most investors, but it’s still not an easy thing to get right. It usually means the acquisition of numerous different assets, something the average investor would find time-consuming at best. Conversely, with ETFs it is possible to own a complete pool of assets through the purchase of a single tool.
Affordability
Since they aim to replicate indices, ETFs can help investors get a diversified portfolio without the need for continuous transactions. This, ultimately, makes them an affordable option, largely foregoing the kind of transaction fees that can eat away at returns.
Additionally, management fees for ETFs are generally much lower, which significantly brings down their costs. ETFs can help investors hit positive returns for what is a relatively low cost,
Making them a well-suited instrument for building an effective accumulation plan.
Asset allocation
An ETF portfolio allows investors to develop their strategy in line with wider economic trends, without necessarily needing in-depth knowledge of specific actors within the market. Using ETFs you would, for example, be able to invest in emerging markets without having to examine the financial statements of companies based in China.
So, feasibly, an investor could create a portfolio of ETFs themselves. This would still be a complex and time-consuming task to do well, though, so we still recommend having a professional do it for you. The lower costs associated with ETFs (which we’ll come to) mean that this is now a more affordable option than it’s ever been.
Managing volatility
ETFs are, on the whole, less volatile than other investment funds. Volatility isn’t necessarily something to avoid but having more consistent components can stabilise a portfolio.
Being diversified by design, ETFs allow investors to develop long term strategies with peace of mind at the forefront. Of course, there is risk when taking on any type of investment and ETFs by no means constitute guaranteed returns – ETFs can, however, bring a greater degree of predictability to an investor’s portfolio.
Lower fees
When investing in ETFs, investors are generally subject to no entry, allocation, exit, or performance fees. ETF costs are clear and transparent – any good wealth manager should have a fee structure that reflects that. To take Moneyfarm as an example, we use the lower fees associated with ETFs to provide a lower end cost to our users.
ETFs are tax-efficient by nature, too. Most ETFs are given the status of ‘reporter’ or ‘distributor’ – at Moneyfarm, we only use ETFs with these classifications – which makes them subject to capital gains tax rather than income tax.
More control
ETFs are generally to be considered more liquid than mutual funds, making it easier for investors to enter or exit positions. This means that, in the event that you need to raise cash for whatever reason, you can quickly access and take ownership of your savings.
The funds we use at Moneyfarm, for example, work on T+2 settlements, which in basic terms means they are ready to withdraw three working days after they have traded. In contrast, mutual funds tend to take anywhere from one to two weeks. Being exchange-traded, ETFs can trade any time during trading hours, whereas mutual funds only trade once per day. It’s this flexibility that makes ETFs such an attractive proposition.
Ultimately, ETFs are a popular, convenient and effective option for many investors. Having said that, choosing the right ETFs is crucial to a successful investment strategy, and may prove difficult given the wide number of options and factors to take into account.
This is where the new wave of digital wealth managers can help. Today’s platforms offer visibility and control that has previously felt inaccessible to the average investor, while effective use of digital services brings costs down. At Moneyfarm we have chosen ETFs as the basis of the investment portfolios we build for our clients.
For more information about our portfolios, our performance and our use of technology, take a look at our portfolios page. If you want to discuss your existing investments or how the use of ETFs could be factored into your long term financial plan, feel free to get in touch with one of our qualified investment advisors.
Photo by Boudewijn Huysmans on Unsplash
*Capital at risk. Tax treatment depends on your individual circumstances and may be subject to change in the future.
