An Exchange Traded Fund (ETF) trades like a stock throughout the day, but is a basket of stocks based upon an index. These indexes can be as big as the Dow Jones Industrial Average, a particular commodity like gold or a smaller country in Asia. ETF’s can be bought and sold in your brokerage account without the higher fees associated with most mutual funds. Let me explain why you should consider an ETF as part of your investment strategy.
Why should you consider an Exchange Traded Fund?
1. The average American will have 3-4 careers and 10 different jobs in a lifetime. An ETF is a low cost investment alternative to a traditional mutual fund. At one of the many jobs you will have, retirement investments will stay in a higher cost mutual fund. If you rollover your retirement funds into an ETF, you will save a nice sum of money, let me explain. The average expense ratio for a traditional mutual fund is around 1.4%. While on the other hand ETF’s have an expense ratio on average of .5%. Over ten years you have made yourself 10% just on expenses alone.
2. Get what you want and nothing more from an ETF. Once investors see the stocks that are held in their mutual funds sometimes they quiver. If you had financial stocks in 2008 and had an idea things were going downhill in the economy, your mutual fund with those financial stocks would have been drug down. ETF’s offer you exposure to sectors they represent, whether it is stocks, bonds, or commodities. Whatever your read is on the overall economy you can use ETF’s to profit from it and leave out the sectors you do not feel comfortable in.
3. Go around the world without having to pick individual stocks. We live in global economy and there will be many opportunities for great growth in stock markets outside of the United States. If you are aware of these trends, using ETF’s will give you low cost access to this growth. Most if not all Financial Advisors will say that some of your portfolio should be in international stocks, ETF’s can fit that recommendation. If you believe in the long term growth in one or two countries, why weight down you portfolio with mutual funds that have countries stocks that you don’t feel strongly about.
4. Mutual Funds do not trade like stocks, but Exchange Traded Funds do. You can buy and sell them throughout the trading day. While this is not relevant to the long term investor, many use ETF’s for trading on a daily, weekly, or monthly basis. When you purchase an ETF you pay a flat rate as if you were buying an individual stock. 10,000 dollars invested in an ETF will cost you around 10 dollars depending on your broker, as compared to a load mutual fund which takes a percentage of the individual investment up to 5%. The rule of thumb is the larger the market capitalization the smaller the expense ratio is for the ETF. ETF’s in smaller sectors have a higher expense ratio, but still compared to the mutual fund cousins, they are a bargain.
5. Capital gains taxes tend to be higher in mutual funds because the managers buy and sale stock more often. In ETF’s because the stock are fixed to an index and are not bought and sold as frequently, they result in less capital gains tax.
Flexibility, low cost, diversification, trades like a stock, and lower taxes are all solid reasons for the individual investor to take advantage of ETF’s. ETF’s are available to anyone with a brokerage account, they will only grow in popularity, and it is never too late to start learning about ETF’s to add another tool to your investment strategies.
