Investors often look to diversification to manage the risk in their portfolios, but it’s a tricky thing to get right by yourself. That’s why investors are increasingly turning to exchange traded funds (ETFs) to help them protect and grow their money.
Funds come in all shapes and sizes, with some aiming to outperform the general market. Unfortunately, the expensive management fees attached to these active funds can diminish investor returns, and they don’t always outperform.
ETFs are a low-cost, simple and transparent alternative to these expensive funds. But how do they work and what’s the best way to invest in them?
What is an ETF?
So, how do ETFs work? A form of passive investment, ETFs aim to track and replicate the returns of an index, specific commodity, bond, or basket of assets.
ETF trading gives investors exposure to a wide range of asset classes and investments, with funds able to track an index like the FTSE 100 or S&P 500, investments like high yield bonds, or commodities, for example.
ETFs are simple investment vehicles. As they’re traded on an exchange, they act like a share on the stock market. ETFs have a bid and ask price – the point at which a buyer wants to buy and a seller wants to sell. Their price fluctuates throughout the day as they are bought and sold by investors. Importantly, you can trade even the best performing ETF in seconds.
This provides investors with transparency and flexibility, which can be essential for people that feel alienated from the traditional financial system.
Why liquidity matters
It’s important you know how easily and quickly you can turn your investments into cash, without this impacting the overall value of your investment. This concept is called liquidity.
Mutual funds are generally priced once a day, and it can take a couple of days to either invest in the fund or withdraw your money. This time can alter the price you pay for a share in the fund.
How to invest in ETFs
When you build your investment portfolio, you need to make sure that it is constructed in a way that suits you and your financial goals. The composition of the investments within your portfolio should reflect your risk level and the market conditions of the time.
Strategic asset allocation defines the long-term goals of the portfolio, while the tactical strategy makes the most of any alternative options along the way. ETF trading can be used as a crucial building block of your portfolio to reach your long-term goals. Their flexibility and liquidity allow you to make the most of shorter-term market trends.
When you’re choosing which ETFs to include in your portfolio, you need to look at the benchmark it’s tracking and monitor its efficiency. How much will it charge you in fees? What’s the tracking difference or volatility of its performance? You also need to make sure you’re getting the diversification you’re paying for.
The ETF universe is huge, and your options are growing by the day. It can feel intimidating when you’re trying to pick the best investments to help you reach your ultimate goals.
Investing on your own takes in-depth knowledge, skill, and quite a bit of money to do successfully. This is why many investors often prefer to rely on experts to invest for them.
At Moneyfarm, we build and manage portfolios to keep them in line with your requirements. We use ETFs to build our portfolios, providing a low-cost, transparent, flexible and efficient investment solution for our customers.
Each portfolio is specifically constructed to match your investor profile, and help you reach your personal goals.
Once you invest your money, you can focus on the important things in life. Our team of experts monitor the markets daily on your behalf, analysing investment opportunities and executing trades – you don’t have to worry about a thing.