Investing can consist of a few different types of securities.
For exchange-traded funds, or ETFs, all those different types of securities can be combined.
ETFs are a combination of various types of assets, like stocks, bonds, and other securities. Investors pool their money together into ETFs and divide ownership. If you invest in ETFs, you own part stocks and bonds in whatever companies that ETF has.
Are ETFs the same as mutual funds?
ETFs are like mutual funds, in that you pool your money together with other investors to own partial shares of assets. This is a lower risk than owning straight shares of one company or a few different stocks. Rather, you own partial shares in many different stocks. In short, it’s a low-risk way to diversify your portfolio so you aren’t investing too much into only a few areas.
The difference between ETFs and mutual funds is that ETFs are more flexible when it comes to trading. They’re also cheaper to invest in with lower costs to manage. ETFs are usually passively managed, which means fewer fees for investors. Mutual funds are actively managed, which means you’re paying an investment professional to handle your funds.
ETFs are still kind of new and might not offer the same selection as mutual funds. Low-cost is nice but low selection isn’t.
What are ETFs good for?
If you’re thinking about buying ETFs, here’s some pros:
- Low expenses. The Wall Street Journal notes that the average expense ratio for ETFs is 0.44 percent. That means you’re paying $4.40 in annual fees for every $1,000 of your investments. Mutual fund expense ratios vary and can average up to 1.25 percent, depending on the fund type. Some can cost much more.
- Stock-like trades and earnings. ETFs are bought and sold like stocks, or at any time of the day. Mutual funds are priced at the end of each trading day. This means you can buy and sell an ETF at any point in the day — you don’t need to wait. You can also earn profits on shares, like dividends.
- No minimums. Unlike mutual funds or some brokerage accounts, you don’t need a minimum balance to start investing in ETFs.
- Instant diversification. You can start investing in many different stocks, bonds, and other assets all at once and right away. You can buy a variety of assets at once without selecting each type of security individually.
When are ETFs bad?
Since ETFs are bought and sold like stocks, there’s a brokerage commission fee for every transaction. Commission fees can be costly to your investments, especially when you don’t have much to begin with. Even though there isn’t a minimum for ETFs, investors should be wary of hefty fees.
ETFs are still new compared to other investment strategies. Since they don’t have the same amount of options as mutual funds, you might be limited in your investments. And because they’re traded like stocks, you could end up with lots of extra fees from trading. Mutual funds might cost more to be actively managed, but trading fees can get expensive.
Should you invest in ETFs?
Before you get into exchange-traded funds, ask yourself a few questions first.
- How much money do I have to invest? ETFs have lower fees, but trading fees can rack up extra costs. Make sure you have plenty in your investment account before getting started.
- Where am I in my investing journey? If you’re starting out, ETFs, mutual funds, and other index funds are a great way to diversify your portfolio with a small amount of money. If you’ve been following the market for a long time and understand it well, you might pass on ETFs for another type of asset.
- How do I know which ETF to choose? There are a lot of options for ETFs, including market ETFs, bond ETFs, commodity ETFs, and a dozen more. Make sure you know which ETF to put your money in before making the leap.
As you decide if ETFs are the right decision for you, be sure to weigh all your options. Look over minimum investment requirements, advisor costs, and other fees before making your choice. ETFs aren’t always the right decision for everyone, but could be a great investment to add to your portfolio.