ETFs are exchange-traded funds that trade like common stocks on exchanges while replicating the returns of an index, specific commodity, bond, or range of assets. They hold a basket of assets and offer the diversification, low cost, and tax efficiency to investors. ETFs are an ideal method of investing for young investors due to their excellent features and offerings. Famous ETFs include the S&P 500, FSTE 100, Vanguard Value ETF, NYSE Technology ETF, and ARK Industrial Innovation ETF.
Benefits of Investing in ETFs
Low Fees: Most of the ETFs are managed passively. It implies that there is minimum human intervention and the need for portfolio managers. As a result, investing in ETFs does not incur very high management fees compared to investing in stocks or mutual funds. The expense ratios of ETFs are generally lower than those of mutual funds, usually between the range of 0.01% and 0.25%. Additionally, although ETFs are traded on the exchange like stocks, trading a basket of stocks is considered a single transaction and many brokerage firms offer commission-free ETFs trading, making them extremely cost-effective. The significant benefit of lower fees and costs of ETF investing is that the fees do not burn a hole in the profits generated, leading to more savings and higher returns as compared to mutual funds and stocks. Thus, overall ETF investing adds more value to the investments owing to its cost-efficiency.
Portfolio Diversification: The most significant advantage of investing in ETFs lies in the diversification it offers. By investing in just one ETF, investors get exposure to an array of assets and securities, including stocks, bonds, commodities, and currencies. Investors also get to diversify their investment portfolio across specific industries, sectors, geographies, and strategies through ETF investing. As a result of diversification, investors get to incorporate multiple views in their portfolio and still keep the overall risk and volatility of the portfolio low.
High Liquidity: Another top reason for ETFs to be a good way of investing is their liquidity. As ETFs are bought and sold many times during a trading day, they can be liquidated as and when you want, making them more liquid than mutual funds that can only be traded at the end of the trading day. The liquidity of ETFs also varies with the securities they invest in; therefore, ETFs that invest in actively traded securities are more liquid than others that do not. It is also possible to sell ETFs short or on margin and their prices keep updating throughout the market hours. Thus, ETFs offer the advantage of ample liquidity, just like stocks.
Transparency: The entities behind managing ETFs are required to publish a list of the assets in their funds daily. As a result, ETFs are highly transparent and straightforward in their approach. Investors are aware of what they are investing in and what they can expect. The similar requirements do not apply to mutual funds and mutual funds investors are generally not aware of the products in their portfolio until the end of a quarter Thus, ETFs are an effective way of investing due to their transparency and accountability.
Tax Efficiency: Another reason for ETFs to be an excellent way of investing is their tax-friendly nature. Most of the ETFs are not managed actively, so they do not generate high capital gains that would add to investors’ income. Moreover, capital gains on ETFs are realised only when they are sold. Investors are also allowed to create or liquidate new shares without selling their investments in ETFs. Therefore, investors can choose when to sell the ETFs and impose capital gains tax on their income.
Simple Structure: In addition to the low-cost structure, high liquidity, diversification, and other benefits, ETFs are considered a good way of investing for their simplicity. The structure of ETFs is easy to understand for novice investors and makes them an ideal investment choice to begin the investing journey. A product as simple as ETFs is easily understood by investors and lowers the barriers to invest in specific industries or indices. It is uncomplicated to create an ETF portfolio, trade it, and execute trading strategies. Therefore, ETFs are a suitable way to begin investing.
ETF investing also has certain drawbacks; however, the pros outweigh the cons. There is no doubt that ETFs are a good way of investing because of their simple and low-cost structure, high transparency and accountability, portfolio diversification, and tax-efficiency.