Does investing seem complicated to you? If so, you might find yourself unable to take the first step. And this lack of action can cost you big in returns over time.
But you can reap the rewards of investing without being an expert. Just keep it simple by considering this investment vehicle before making your next move.
Exchange-traded funds (ETFs) are similar to mutual funds. Instead of building a portfolio filled with stocks you pick yourself, an ETF pools different companies together to give you a lot of diversification. It can track an index like the S&P 500, a sector like energy, or a commodity like gold.
Here are three reasons to include ETFs in your portfolio.
1. They're easier to buy exactly when you want
When you buy a mutual fund or index fund, you purchase it one time a day — at the end of trading hours. And the price you get will be determined by whatever price the securities inside the fund closed at for the day. This means that if you buy or sell a fund at noon, you will have no clue at that point how many shares you'll get or the price. Instead, you will designate a dollar amount, and the number of shares that you get will all depend on the closing price that day.
An ETF trades like a stock — the price is constantly changing based on how the index it mirrors changes throughout the day. Because of this, when you buy or sell an ETF, you have a lot more flexibility with trading it. You can buy or sell at any time during normal trading hours.
This gives you more certainty about the price in making transactions. You can specify the number of shares, and you'll know immediately the dollar amount involved.
2. They're simple to understand
When you invest, it's important to understand what you're buying. There's no need for fancy financial calculations, but you should know things like the types of products and services provided by companies you invest in. And if you're buying mutual funds, understand the types of investments or companies that make up the fund — like whether it includes small or large companies, growth or value stocks, or domestic or international companies.
Many mutual funds are actively managed. That can mean that the actual stocks inside the mutual fund can change dramatically over time. Moreover, it can lead to higher expense ratios and tax consequences if there is a lot of trading by the fund managers.
But because you're buying the index that an ETF tracks, you'll experience very little turnover. This helps make ongoing research of your investment easier. It also helps keep the fees and taxes low because there's infrequent trading by the fund.
3. They require very little maintenance
If you own multiple asset classes like stocks and bonds, your portfolio might need rebalancing whenever there is a big shift in the stock market. For example, in 2008, if you owned a portfolio that consisted of 60% stocks and 40% bonds, a rough year for stocks would've reduced your overall allocation to 47% stocks and 53% bonds by the end of the year.
Ideally, you would sell some of your bonds and buy some more stocks to maintain your initial allocation. If you didn't, you would've experienced below-average returns based on your risk tolerances whenever the stock market rebounded. The table below shows how each portfolio would've performed in the following years when the market rebounded.
60% stock/40% bonds
47% stock/53% bonds
If your portfolio gets more complicated by adding something like individual stocks, you could have even more work on your hands. Now you would also need to do ongoing research so that you can make sure that your opinion about a particular holding hasn't changed and that it still matches your risk tolerances. Because ETFs are so simple and don't change much, there really isn't much maintenance needed. They are one of the very few investments that you can set and forget.
Investing to grow your wealth shouldn't be hard. And incorporating ETFs into your portfolio can make investing go from complicated to simple. It could grow your portfolio substantially over the years with a lot less time and work than other types of investments.
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