Why are ETFs so popular now?
There is no shortage of fad-driven investments out there right now and, no, we’re not talking about cryptocurrencies. One of the more popular investment vehicles to emerge during the past five years is what is known as an exchange-traded funds or ETFs for short.
In short, these funds offer all of the advantages of a stock in terms of liquidity with the stability and expertise of a mutual fund or the broad diversification of an index fund.
Traded like stocks on the open market, these ETFs can specialize in literally anything that an investor could possibly want to fund such as the aforementioned cryptocurrencies, real-estate developments, casinos, consumables, and so on.
Of course, there are a few things that investors should know about ETFs that make them somewhat different from regular stock.
For one, they come with expenses particularly if you sell the security before a certain amount of time.
This is to limit the risk involved to other holders of the ETF and to keep its price relatively stable; again, much like a mutual fund would do for its members.
Because the ownership of an ETF is divided up among its shareholders, they are entitled to the benefits that ownership entails such as dividend payments (if issued) as well as any stock splits or mergers that might occur.
Aside from the mechanics of an ETF, there are some other benefits that are driving their popularity on the market.
We have broadly summarized seven of the major benefits that ETFs offer over other options below:
Low Barriers to Entry
Probably the single strongest advantage and ETF has over traditional funds like Vanguard is that it has remarkably low barriers to entry in terms of cost and commitment.
Whereas even the most modest funds can require £5,000 to open an account, an ETF is often either the nominal price of the share on the open market or even some fraction thereof with the advent of fractional share investing and its popularity.
Because of their low costs, ETFs give investors instant access to broad diversification and a range of market strategies from highly speculative to staid instruments such as bonds.
Again, when it comes to even the most modest funds held by the major players, achieving this kind of diversification requires multiple buy-ins and huge commitments to different funds that may or may not suit an investor’s needs.
With an ETF, if the investor is not happy with the performance, it can be sold on the open market in an almost effortless process.
Most people understand how a share of stock works. When you move beyond that, however, things get murky for the average investor. ETFs provide the benefits and expertise that mutual funds bring but with the mechanical convenience of a share of stock.
Investors can watch its value rise and fall, reap dividends and other benefits of ownership, and increase or decrease their stake as needed without the need for saving thousands of dollars.
Most of the costs associated with an ETF are quite minimal compared to the huge fees you can sometimes face to open a traditional account. Fees not only erode your gains over time but they can also make a bad investment even worse if you can’t exit it in good time.
Additionally, ETFs allow investors to set aside funds for something other than investing such as using an ETF as an additional savings vehicle for a home or other major purchase.
The liquidity associated with ETFs combined with the zero-commitment necessary to make them work both combine to create an ideal investment vehicle in a near-zero interest savings account situation.
Depending on where you live and what your individual tax situation might be, there could be some significant tax advantages investing in ETFs over a traditional fund.
To explain how ETFs can be more tax-efficient, it helps to use a simple example and, again, we’ll turn to a managed fund as compared to an exchange-traded fund. In a managed fund, you incur taxable events throughout the life of the fund.
Every time it is rebalanced or management activity takes place, you create a taxable event. With an ETF, you create a taxable event at the sale of the security if you have made money.
Of course, there is the consideration for dividends which is another matter entirely but, bottom line, if you are investing in an actively managed fund then you are incurring multiple taxable events throughout the year as opposed to the simple one-time feature of an ETF.
As you age, your needs as an investor will change. Overhauling a portfolio of managed funds can become a huge hassle and even a massive tax burden if not handled properly. But ETFs allow you to change your strategy as needed, this year, this month, or whenever you might need to pivot to something new. Want to get in on the crypto craze? There’s an ETF for that. Want to fund real-estate development? There’s an ETF for that. Combine this advantage with those listed above and you have a great tool for creating and broadening wealth that doesn’t require a massive time or financial commitment.
ETFs are ideal for passive investors who want the advantages of active management without the tax inefficiencies and large buy-ins funds can require. Unlike investing in a single company stock, ETFs constantly shift their mix of holdings in order to, again, provide investors with stability and reliability when it comes to returns.
The challenge with investing in the open market in company stocks or other instruments is that making money is both a matter of time and research. You’re unlikely to time the market or beat the market so why even try? Unless you want to make investing a full-time hobby akin to a job, it might be best to leave it up to the experts and an ETF lets you do just that.
Links that may help you
Find out a little bit more about ETFs