There are many reasons why ETFs are better than stocks. First though, let’s look into what an ETF is exactly. ETFs are a form of investment that can be bought and sold like any other stock. An ETF is a security that is invested in underlying assets (this can include gold, currency, futures, bonds, stocks) and shares the risk and rewards of those with purchasers. ETFs are passive securities that track certain indexes or assets. There are two main types. Physical ETFs and Synthetic ETFs. Physical funds purchase the actual asset or stock that it wishes to track. Synthetic funds buy into derivatives of the assets or stocks that it wishes to track. Synthetic ETFs pose other risks that need to be looked at before buying. There are often some funds that look like ETFs but do more than simply track an asset or index. For example, they may try to outperform an index or seek enhanced returns. The risks of these products can be different and sometimes much higher than the risks of ETFs.
All the benefits of diversification in one investment
Index investments are great for diversification. When you create a portfolio of highly diversified investments, the volatility of the indexed profile is much lower than the investments that create it. An average stock in any market will be more volatile than the stock market index itself. This is why diversification means safety. More simply, the index ETF will usually have less sharp moves day to day and is more secure against collapse or other negative black swan events compared to the individual stock or even a portfolio of a few stocks. Diversification without building a large portfolio is what makes ETF’s so great.
Don’t follow the trend of most stocks
In general, and in the long run, most stocks lose money. Period. It is usually the rare big winning stocks that skew the view that certain markets have. This means picking the right stocks. That’s where ETF’s come into their own. If you were to ask a number of long term investors, most of them would underperform the relevant index and a few would be better off than the index. These winners would be in the green by a lot, but make up a small proportion of the overall investors. Note that a lot of the stocks that many of these investors would have invested in at the start, no longer exist. Buying an index ETF with a highly diversified set of stocks, you are avoiding the pitfalls of choosing your own portfolio. You’ll have a much better chance of including those rare winners in your portfolio which more than make up for the numerous losers. In other words, there are lots of small losers, and only a few big winners. Having both in your portfolio means you end up with a win.
Management is simple
Why should you have to research 15-200 stocks individually to find if they are right for you. That’s a lot of due diligence and a lot of wasted time. ETF’s have a single prospectus document which keeps it simple for everyone involved. The only difficult part may be actually choosing an ETF. But that doesn’t need to be as hard as it first seems. Many of the best funds track the large-cap S&P 500 or the S&P MidCap 400, or look at getting a much broader perspective of the market through wider investing. Tread carefully and even stay completely away from specialized ETFs that pose as being more profitable due to the specific market they target. Specialized ETF’s are very much a marketing gimmick. Stick to broad when you’re starting out and you can’t really go wrong.
Less commissions, less fees, less overhead
Buying ETF is essentially betting on some form of index. It’s a single purchase which naturally attracts just 1 fee. When you buy an ETF, you only pay a commission to your broker and a nominal fee (usually less than 1% per year.) If you were to buy all the same stocks and bonds yourself, you would be paying a commission and brokerage charge for each stock. It can add up to a lot of money. Yes, your ETF manager still has to pay commissions to their broker to buy the stocks in it but that is not your concern. ETF manager’s asset profiles are often so large that fees are minimal. You get the benefit of being asset backed without owning any yourself.
You should also note that dividends payed by companies within the ETF are immediately reinvested back in to the fund. Do your research though, as some funds (including unit investment trust ETFs) are not automatically reinvested. This is especially common in the United States were SEC rules state that passive ETFs cannot reinvest dividends back into the fund. Put simply, ETFs that don’t reinvest ‘lag’ behind those that can.
Invest in ‘hard-sectors’
ETF’s provide a benefit that almost no other funds or stocks allow you to have. You are able to invest in so-called ‘hard-sectors’. Investing in gold bullion or other commodities through ETF’s is extremely simple and against benefits from diversification. You can also get in and out of those hard sectors with a single sale. It’s a single security, not many; at least when it comes to buying and selling on your end. You also get access to international markets much easier than you otherwise would. Buying a local ETF that invests in international stocks means you’re really just buying a local security. However, you get the benefits of investing internationally. This ties in with the benefit of diversity, of which, location diversity can be one form of it. Just keep in mind that currency issues may come into play and affect your profitability.
Make dollars and sense
In general, ETF’s just make sense for amateur and professional investors alike. You don’t follow the ups and downs of every other stock and you get the great benefits of diversification. What’s more, managing your ETF investments is simple, as compared to managing all the individual stocks that you would need to hold yourself to get similar benefits. ETF’s have less commissions, less fees and less overheads while also allowing you to invest in ‘hard-sectors’. Take a look at ETFs, they’re worth your time.
Byron Simpson is a qualified business/finance writer expert in investment, debt, credit cards, Passive income, financial updates. He advises in his blog finance cent.