ETF or exchange-traded fund is a type of investment. It consists of hybrid mutual funds as well as closed-ended funds. ETFs include assets such as stocks, bonds, and commodities, and market exchange rates. It can be traded whenever you trade stocks.
- Lower costs
A crucial advantage of ETFs is lower costs. It also provides instant diversification, tax efficiency, and liquidity. As an investor, you can purchase in small amounts, and there is a wide range of alternatives and even exotic investments available.
Because ETF trades similar to stocks, you can purchase a diversified portfolio with a low commission. The amount is typically $5 per stock. Besides, ETFs also have lower expense ratios than mutual funds.
ETFs trading and US stock exchanges are now in the hundreds. The selections are deep and wide-ranging and cover significant indices, sectors, industries, and all sizes, such as large-cap, mid-cap, small-cap, and even micro-cap.
There are numerous ETFs in the income area. Bond ETFs will include terms such as long, mid-term, and short. There are also multiple levels of quality, such as treasury, corporate, and high-yield. You can also choose from regions such as the US, individual countries, and emerging markets.
You can trade ETFs on the market anytime, similar to stock trade. You are not limited to trading at the end of the day. It is a critical benefit, especially when there is high volatility.
- Tax efficiency
A majority of ETFs are not actively managed. Instead, they are programmed to follow a specific index because it doesn’t have high capital gains, and the income is passed down to owners annually. Because of this, investors have better control whenever they incur taxes.
- Sector investing
ETF investments can target specific sectors of the economy. It allows investors to have a diversified position even in a small slice of an industry where they want optimum exposure.
- ETFs can be purchased in small amounts
Since ETFs can be traded similar to stocks, there is a vast advantage for position sizing. Small positions can be purchased with zero minimum investment. It allows you to scale in or scale out of a particular position. It also provides you with the flexibility to take a single small position in a specific ETF.
- Availability of alternative investments
ETFs provide investors with the flexibility to take positions in alternative and even exotic investments that may be unavailable in other forms to small-time investors. New products are available regularly and include ETFs in commodities, hedges, and leveraging long and short positions in indices and sectors.
What is the disadvantage of the ETF?
A significant disadvantage of an ETF is over-diversification. Generally, ETFs are not managed actively but are programmed to follow a specific index. Because of this, the index and the ETF may not own the very best stocks.
It may be better to purchase a limited number of the best companies rather than purchase an entire index. It is particularly true with ETFs that track small stocks’ indices, such as a specific sector or an industry.
How to mitigate disadvantages in investing in ETFs?
Every disadvantage of the ETF can be minimised by investing in an ETF as well as stocks. There are instances where it is better to invest in ETFs and, in some cases, better to invest in individual stocks.
Smaller investors who utilise ETF funds exclusively might want to consider purchasing individual stocks as their portfolio grows. It is recommended to start this process once your portfolio reaches the range of $25-$35,000.
ETFs are the ideal investment vehicle for amateur investors or investors with smaller portfolios. Investors with more extensive portfolios can also benefit from significant diversification in a particular country, segment, or industry. It can be a valuable tool to mitigate risk and improve a portfolio’s returns when used wisely.