Investors often look to diversification to manage the risk in their portfolios, but it’s tricky to get it right by yourself. That’s why investors are increasingly turning to exchange-traded funds (ETFs) to help them protect and grow their money.
Invest in ETF: Summary Table
|⚖️️ ETF stands for?||Exchange-traded Funds|
|🔍 Types of ETFs?||• Bond ETFs|
• Equity ETFs
• Commodity ETFs
• Passive & Active ETFs
|👌 Are ETFs a good investment?||An ETF is a good investment for diversification and risk management|
|ℹ️ Popular examples of ETFs?||• SPDR S&P ETF 500 (SPY)|
•Vanguard S&P 500 ETF (VOO)
• PowerShares ETF (QQQ)
• Vanguard Total Stock Market ETF (VTI)
Funds come in all shapes and sizes, with some aiming to outperform the general market. But 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 ETFs?
What is an ETF?
So, what is an ETF, and how do ETFs work? A form of passive investment, Exchange-traded funds ETF 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 where a buyer wants to buy, and a seller wants to sell. As a result, their price fluctuates as they are bought and sold by investors throughout the day. Notably, 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.
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.
When comparing ETFs vs mutual funds, 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 ensure you’re getting the diversification you’re paying for.
The ETF universe is enormous, 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.
Before you invest in ETFs, you know to know the different types of ETFs, as each type is used to achieve various financial goals and investment strategies.
Invest in Bond ETFs
Bond ETFs are financial products that allow you to invest in bonds without actually owning them, basically a portfolio of bonds. Bond ETFs are less volatile than stocks and offer capital preservation for investors.
Bond ETFs help diversify your portfolio with fixed income financial instruments and are more liquid than individual bonds or mutual funds. Bond ETFs may trade at a discount or premium to the value of the underlying bonds.
Bond ETFs are passively managed, can be traded in the market and offer an investment opportunity similar to stocks. There are many different types of bonds, including government bonds, corporate bonds, junk bonds, and municipal bonds.
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In addition, bonds can provide an income from interests via dividend payouts. Examples of bond ETFs include iShares Global Government Bond UCITS ETF, Vanguard Global Aggregate Bond UCITS ETF, and Vanguard UK Inflation-Linked Gilt Index Fund.
Invest in Stock ETFs
Stock ETFs are baskets of stocks to track a specific industry that might include high-performing companies and new entrants with potential growth. Stock ETFs have lower fees than stock mutual funds. Stock ETFs allow investors to gain exposure to a specific market without actually owning the shares themselves.
Stock ETFs are more actively managed like mutual funds, as stocks are bought and sold periodically. In addition, when compared to bond ETFs, stock ETFs are very diversified. Examples of stock ETFs include the S&P 500 ETF, Dow 30, and FTSE 100 ETF.
Invest in Commodity ETFs
Commodities ETFs allow investors to gain exposure to specific commodities without investing directly in them. Commodity ETFs are very risky because they invest in physical commodities such as agricultural goods, precious and base metals, and natural resources. Investments can range from individual commodities to a basket of commodities.
They are also a great way to make money during times of economic instability. These ETFs are often used to hedge against inflation or when investors want to see profits when the stock market is sputtering. They are also used to speculate on the price of commodities.
There are several types of commodity ETFs, but the most popular ones include equity ETFs, physically-backed funds and future-based funds. Equity-based commodity ETFs invest in companies that store, transport, or produce commodities. Examples are Global X Lithium & Battery Tech ETF and iShares Diversified Commodity Swap UCITS ETF.
Physically-backed commodity ETFs invest in companies that hold physical commodities, all precious and base metals. Future-based commodity ETFs invest in futures, forwards and swap contracts. Some commodity ETFs track the performance of a commodity index, such as the UBS Bloomberg CMCI Index, which tracks 29 commodities across 5 different sectors.
How to buy ETFs
Here are the steps to take when you want to buy an ETF.
- Open an account: Opening an account with an investment platform or a broker is the first step.
- Choose the type of account: The type of account can be a general account, a retirement account or other investment account.
- Research the ETFs: Investors buy ETFs like they buy shares, and they are spoilt for choice from a wide variety of ETFs. So, extensive research needs to be done based on an investor’s aim: income or growth.
- Decide on an ETF strategy: Investors have to decide which investment strategy works for them. It can range from asset allocation to passive or aggressive investments.
ETFs: Pros and Cons
There are some of the advantages of owning ETFs.
- Tax efficient: An ETF investor incurs capital gains tax when they sell the ETF, unlike actively managed mutual funds. This means that there is no capital gain or loss involved.
- Diversification and risk management: ETFs are used as a risk management tool due to their diversification properties. Diversification gives investors access to various stocks across different sectors and countries, which mitigates the risk of owning a particular asset.
- Low fees: ETFs are passively managed, so they usually lower annual fees. Also, because most ETFs track an index, they typically have a low expense ratio, which means lower administrative costs.
- Trading flexibility: ETFs trade like regular stocks in the stock market with real-time prices. Since ETFs trade during the trading day, it creates trading liquidity, unlike ETFs vs index funds, where index funds are traded for a set price at the end of the trading day.
The disadvantages of investing in ETFs include:
- Lower dividend yield: Some ETFs pay out dividends to investors. Sometimes, the dividends from ETFs might be lower than the dividend paid out by individual stocks.
- Higher fees: Actively managed ETFs will incur higher fees, and the costs are higher when comparing trading ETFs with individual stocks as there are no management fees attached to trading stocks.
- Less diversification: Country or sector/industry-specific ETFs can limit diversification as investors might only have access to large-cap stocks.
- Low trading average: ETFs can have very low trading averages, and this can cause a liquidity problem.
Active ETFs vs Passive ETFs
Investing in ETFs can be active or passive. Most ETFs are usually passive ETFs because they try to mimic the performance of an index, and they can be sector-specific or diversified. However, some ETFs are actively managed.
Gold ETFs are a great example of an active ETF because they invest in companies that mine gold. Active ETFs have portfolio managers deciding what securities to include in their portfolios; they usually don’t target an index of securities. Passive ETFs are more beneficial than passive ETFs, but they are more expensive.
What does an ETF cost?
Before you invest in ETFs, you need to know what it will cost you. The costs of ETFs are also known as the expense ratio. Expense ration includes administrative costs, management fees, and other expenses. However, the cost of ETF buys and sells is omitted. The investor pays these ETF fees, and the fees are taken out of the earnings.
The ETF fees are relatively low and range from 0.05% to 1.0%, making ETFs one of the most affordable financial instruments. Always aim for lower fees so that you can claim more profit.
Is ETF good for beginners?
ETFs are perfect for beginners as many are passive investments with exposure to the overall stock market. ETFs are low-risk investments that are highly cost-effective, and it is an excellent way to diversify their portfolio.
Is it better to invest in ETFs or stocks?
Choosing between an ETF or stocks depends on your risk tolerance and what you want to achieve with your investment. ETFs are less risky than stocks and a great diversification investment vehicle (exposure to various asset classes). Also, If you don’t know anything about the companies in a particular industry, an exchange-traded fund is probably your best bet. However, stocks have the potential to earn higher returns.
Can you hold ETFs in your retirement account?
You can hold ETFs in your retirement account if you make trades. However, it is easier to have an investment account with a broker or certified financial institution.