5 Reasons To Love Investing in ETFs
5 Reasons To Love ETFs
What are ETFs?
Exchange Traded Funds, or ETFs, have quickly become some of the most popular investments for the everyday investor to grow their wealth and overcome inflation.
ETFs are baskets of securities, where money from investors like you and me is pooled together to invest in a number of different assets such as stocks or bonds. Collectively, this allows us investors to invest in multiple different assets in a single investment.
Reasons to love ETFs
1. Beginner-friendly investment
In terms of both understanding and accessibility, ETFs are one of the simplest asset classes for new investors to get into. There are countless resources online for investors to research about how ETFs work and what ETFs there are.
ETFs can also be easily bought and sold just like regular stocks on investment accounts.
2. Diversification - a hedge against ignorance
An implicit feature of all ETFs is diversification. Since ETFs are bundles of assets, the risk of any individual investment failing is buffered for by the other holdings of the ETF.
Let’s say you were to invest in individual shares of the company Starbucks, versus investing in an ETF that has 50 holdings, one of which is Starbucks.
If Starbucks stock were to tank, the investor who bought individual Starbucks shares would suffer the full blow, whereas the ETF investor would see a decline proportional to the size of the Starbucks holding within the ETF.
3. Low fees make it a cost-effective investment
A huge benefit of ETF investing is the cost-efficiency. Exchange Traded Funds (ETFs) are just one of the many types of investment funds, but they are one of the cheapest. This is because most ETFs are passive funds that track specific indexes.
As opposed to professionally managed mutual funds, ETFs have much cheaper expense ratios, which represents the cost you pay for investing in a fund.
ETFs generally have expense ratios of less than 0.1% for ETFs that track broad market indexes like the S&P 500, and usually around 0.5% for ETFs that track niche indexes, like those of specific sectors.
Compare that to actively managed mutual funds that tend to have expense ratios of above 1%, and the difference is really significant when compounded over time. And that’s not even mentioning the fact that most actively managed funds fail to beat the market.
4. Risk-to-reward ratio
As mentioned earlier, due to their diversification, ETFs are generally much lower risk assets than individual stocks. But this reduction in risk also comes with a reduction in potential returns.
By buying an individual stock, you are not only absorbing the full downside should the stock underperform, but you also benefit from the full upside.
An ETF investor only experiences a fraction of these swings both ways. That said, for many investors, both individual and institutional, ETFs have a more favorable risk-to-reward ratio than individual stocks.
In investing, returns cannot be mentioned without their associated risks. Diversification is a hedge against ignorance and lack of conviction.
So if you’re not fully convinced that a particular company will perform well, ETFs seem to be a much better option – steady returns while keeping risk in check.
And statistically, most stock pickers fail to beat the market anyway.
5. Passive, long-term growth
ETFs are a great “set it and forget it” option for investors. In particular, ETFs that track broad market indexes such as the S&P 500 which is essentially the benchmark for the American economy.
Though the S&P 500 goes through periods of significant volatility, it has never produced a negative return over any 20 year holding period of its generations-long history.
Market crashes and economic downturn come and go every few years as part of the economic cycles, but broad market ETFs have withstood such winds and come out on top time and time again. It’s no wonder that they’re a core holding in many investors’ portfolios.