It’s only been just over 20 years since Exchange-Traded Funds (ETFs) were approved for public trading on the New York Stock Exchange, but this new kid on the block is proving to be one of the brightest stars ever.
In just two decades it has risen to be one of the most popular types of exchange-traded products.
To those who are unfamiliar with the product, ETFs work like a stock meaning that they are traded on the stock exchange. But they are actually an investment fund, holding such assets as stocks, bonds or commodities.
Only authorized large broker dealers like BlackRock Inc., State Street Global Advisors and Vanguard Inc. who have entered into agreements with the ETF distributor can actually buy and sell shares from or to an ETF, and then only in large blocks of tens of thousands of ETF shares called “creation units.”
Should you consider adding ETF's to your investment portfolio?
Generally speaking, yes, but like everything in the financial world, that answer carries a number of caveats.
Let’s look at the advantages first.
First there’s the convenience factor. Unlike an index, you can purchase an ETF with one single transaction. You allocate your investment budget and you can secure your entire mini-profile with a one shot deal as opposed to chasing each stock separately. Pretty much everyone with a full schedule likes the one-stop shopping advantage.
There’s an added bonus to that as well. Since your purchase an ETF with just one transaction, managing fees tend to be lower.
Additionally, you can secure some types of assets other than securities, and one of them is gold. If you want to hang onto a little security in tough times, the GLD ETF physically buys and stores gold. The physical gold bars are being stored in London and are audited twice yearly. GDL EFT is said to currently own more physical gold than all but three national governments.
ETFs are also reassuring to the person who is relatively passive in their investment strategy. If the stock market takes a dive, you can either just sit tight and ride out the storm with your ETF, or you can sell it when the drop hits a designated point and wait until the storm passes. You can simply place a “stop-loss” order on it like any other stock and it will be sold.
Secondly, ETFs offers some basic tax advantages because of how each trade is structured. What this means is that you will likely pay less capital gains tax for ETFs than you would for regular mutual funds.
The difference is that when your daily mutual fund trade posts a gain, capital gain taxes are incurred immediately. But for ETFs, your capital gains tax is not realized until the ETF assets are sold with the total fund.
Thirdly, ETFs are relatively simple to understand and easy to get involved with. For example, if you want to invest in a specific industry like technology, forestry or housing stocks, you can do it all with one single trade. Because of the many and varied types of ETFs available, investors can more readily achieve their specific financial goals by targeting their investments of choice, an option not as easily accomplished in a traditional mutual fund.
One of the most basic advantages of investing in ETFs, however, is the ease with which your entire portfolio can be moved from one investment firm to another, should you wish to do so. With mutual funds, simple transfers cannot always be accomplished. On occasion, the fund positions actually have to be closed before the transfer can happen, and that is a headache waiting to happen.
The investor is burdened with more fees and commissions, and may even be hit with capital gains taxes.
When you want to transfer your ETF portfolio, the move is a simple switch. ETFs are a highly portable investment, and that in itself is a strong advantage in a volatile world.
Keep in mind that what can be seen as an advantage to the personality of one investor, however, may be a detractor to another. In the case of ETFs, if you need the kick that comes from suddenly seeing your stock portfolio jump 10 to 15 percent in a certain, that is unlikely to happen with your ETF because of the diversity of its profile. However, if your temperament is distressed when you experience significant downturns from your stock investments, you will be more comfortable with the ETFs because just as they don’t soar to the same extent, they also don’t decrease to the same extent.
What are some of the other downsides of the ETF investment?
Some may be far less active on the market than traditional stocks. Depending on the industry sector in particular, some ETFs are not traded as actively as others. Investors may be frustrated in such circumstances and might actually do better in a managed fund.
There may also be international limitations in how many ETF products are available, depending on the country in which you live. While the United States has totally embraced ETFs and a tremendous variety of products are available, in some other countries their popularity has been slower off the mark and there may not be all the options that you seek as an investor. Check out your particular marketplace in advance of making your decision.
Finally, as with all investment strategies, you need to speak to your investment planner and insure that ETFs are the right vehicle to drive your individual strategy.
For example, if you have a long-term strategy to your investment portfolio, you may be steered away from ETFs which create more of an immediate advantage for short-term investors.
Knowing your own goals and time allotted to achieve them is crucial in making any investment decision. There is no “one-size-fits-all” when it comes to selecting the best investment products to get you where you want to go.
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