One of the most important aspects of forming a proper investment portfolio is to ensure you diversify your holdings. This means you need to spread your risk around many different assets. In other words, you do not want all of your invested capital dependent on the performance of just a single market asset. Fortunately, there is a type of investment vehicle that allows you to quickly provide diversification to your investment portfolio. This financial instrument is known as an exchange traded fund (ETF).
What is an ETF?
An ETF is an investment vehicle which pools together numerous assets into a single security, similar to a mutual fund. Generally, an ETF will be designed to track a specified economic sector, market index, commodity or some other type of financial asset. ETFs can even be designed to track specific investment strategies, such as high dividend yielding stocks or low risk government bonds. Traders and investors are able to buy and sell shares of the ETF just like you would with a single stock.
ETFs vs. Single stocks
There are many advantages for investors who decide to buy an ETF instead of shares of a single stock in a publicly-traded company. ETFs provide investors with instant diversification since you will be invested in many different stocks, bonds and other assets when entering just a single market position. A single share of an ETF can mean you have invested in hundreds or even thousands of different assets.
ETFs vs. Mutual funds
Although both ETFs and mutual funds provide instant diversification, there are some general differences you should be aware of as an investor. First, ETFs are traded on an exchange with the value of ETF shares changing throughout the day. This allows you to buy and sell shares of ETFs multiple times during the regular market trading hours.
In contrast, mutual funds are only available to be traded once per day after the markets have closed. Also, usually ETFs have more liquidity than mutual funds, allowing you to obtain better market pricing. Additionally, some investors prefer ETFs because they tend to be more cost-effective than mutual funds which helps to maximize profit margins for investors.
Legal status of ETFs
In the U.S. most ETFs are formed as open-end funds which are funds which do not limit the number of investors. ETFs are regulated by the Investment Company Act of 1940 excluding instances where rules have been subsequently implemented that alter relevant regulatory requirements.
How to invest in ETFs
The first thing you will need to do is find a platform offering the opportunity to invest in the ETFs you may be interested in. This could mean online investment platforms, retirement accounts or trading apps.
You will then need to thoroughly research each ETF you are looking to add to your investment portfolio. Consider the risk and volatility of the underlying assets and compare with the potential returns of the ETF’s bundle of assets.
Whether or not you ultimately decide to add shares of any ETF to your portfolio will depend on your overall investment strategy. If you have yet to form a comprehensive strategy you can talk to a financial advisor for help.
ETF shareholders should be aware that the general level of stock or bond prices may decline, thus affecting the value of an exchange-traded fund. Although exchange-traded funds are designed to provide investment results that generally correspond to the price and yield performance of their respective underlying indexes, the funds may not be able to exactly replicate the performance of the indexes because of fund expenses and other factors.
Past performance does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted.
Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The forgoing is not a recommendation to buy or sell any individual security or any combination of securities. Be sure to contact a qualified professional regarding your particular situation before making any investment or withdrawal decision.