A quick search of exchange traded funds (ETFs) will return numerous headlines about how they have grown bigger than hedge funds, how they are smashing records and are completely revolutionising the wealth management industry. But what are ETFs and why are they on the rise?
According to the Financial Times an ETF combines the key features of a traditional mutual fund with those of individual stock. ETFs represents diversified portfolios of commodities, bonds or equities that track specific indices. Like stocks they are traded on a daily basis and the price constantly changes. ETFs can be converted into cash quickly at a reasonable price, are generally cheaper than other types of investments and provide more transparency.
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Why are ETFs on the rise?
There are a number of benefits to investing with ETFs:
- They are more flexible since they are traded on the stock market. Mutual funds are held until after markets close whereas ETFs are traded throughout the day.
- The cost of running an ETF is usually lower than a mutual fund due to the way in which it is managed.
- It is rare for the value of an ETF to deviate from the price of the asset.
- Because ETF holdings are based on an index, the turnover of the underlying asset is low the trading cost is reduced.
- ETFs are more tax efficient than a portfolio of stocks and shares. This is because the buying and selling of the underlying investments happens within the ETF and therefore does not trigger tax events. Investors are only exposed to these tax events when they buy and sell the ETF itself.
- There are hundreds of ETFs available which makes diversification easier. This enables investors to build up the asset allocation that will help returns.
Why do Moneyfarm use ETFs?
Moneyfarm’s investment strategy is built on the idea that asset allocation is one of the main triggers of investment returns. Before ETFs diversification was the preserve of the wealthy few as it was not cost efficient to invest in multiple funds. ETFs allow investors to build up a diverse portfolio in a tax efficient and low cost way. Any cost associated with an investment impacts the real returns of an investment so this is the best way to create efficiency for our clients.