Financial Literacy - Financial Tuneup
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investing
Building blocks for successful investing

ETFs

Exchange-traded funds, or ETFs, have been gaining in popularity in recent years, though they have been around for a while, says Brosious. Good for tax-conscious investors looking to pay less in expenses, ETFs work essentially like a mutual fund with some characteristics of stocks. "These actually trade like an individual security but they are a basket of individual securities, just like a mutual fund," Brosious says.

ETFs follow market indexes in their investing strategy. Because of this, their operating expenses are less costly than those of the average mutual fund, says Flower.

Advantages and disadvantages of ETFs
Pros
  • Like mutual funds, ETFs bring instant diversification with one investment. Unlike mutual funds, "they are very tax-efficient," says Kinder. "For two reasons: one, low turnover because they are mostly index-based, but secondly, you don't have taxes based on other peoples' actions."
  • Generally, ETFs minimize investors' exposure to taxes until the shares held are sold. Lower fees also sweeten the pot. Their expense ratios are comparable to those of index funds.

Cons
  • ETFs can be bought and sold at any time during the trading day. Because they are traded like stocks, each transaction comes with a broker's fee. "If you set up a brokerage account you're going to pay a transaction cost to buy it every time right upfront," says Kinder.
  • ETFs also lack a little bit of the convenience of mutual funds. "Because they trade like a stock, the option of having dividends and capital gains automatically reinvested is unavailable," says Brosious.

CDs

Certificates of deposit provide a fixed interest rate for a stated amount of time. Most CDs have a minimum purchase amount and charge a penalty for withdrawing the principal early. Because of their modest guaranteed return and low risk, they add stability to an investment portfolio.

In general, longer-term CDs pay a higher return than their short-term counterparts. Correlated with the interest rate moves by the Fed, CD yields vary over time. Laddering CDs can guard against the fluctuations of interest rates over time. Rates, investing time frame and the direction of the economic tides could determine the length of a CD ladder.

"If I'm doing a 24-month ladder, I may end up buying three or four different CDs with varying maturities, six months, 12 months, 18 months and 24 months," says Howell. "That way I have a CD coming due every six months and as that CD comes due, I check the interest rates and see what kind of yields are available. And if at that point we're still keeping a 24-month ladder, I'll roll it into another 24-month CD."

Like rebalancing your portfolio at the end of every year, reinvesting in the longest term in your ladder smoothes out returns and removes the guesswork of market timing.

Advantages and disadvantages of CDs
Pro
  • Insured by the FDIC, CDs are low-risk, guaranteed investments.

Con
  • Low liquidity. "Nowadays, there are online banking accounts, which get a pretty aggressive rate of return, and they are more liquid," says Friedhoff. "I would recommend that if you're going to need the money, you go with a savings account. Or if you're going to put money aside for a number of years, you may be better off with bonds or the stock market."

 

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