Exchange-traded funds (ETFs) are investment vehicles that track the performance of an underlying index, commodity, bonds, or a basket of assets. They have become increasingly popular among investors in recent years due to their low cost, diversification, and ease of trading. In this blog, we’ll explore the basics of ETFs, the benefits of investing in them, and some key considerations to keep in mind.
What are ETFs?
ETFs are five times bigger than all of crypto put together, making it a 5 trillion dollar market, growing 150% in the last five years. Approximately one in four U.S. households invested in ETFs making it 20% of total U.S. equity trading volume in 2020.
ETFs are similar to mutual funds, but with a few key differences. Like mutual funds, ETFs pool together the money of multiple investors to purchase a portfolio of assets. However, unlike mutual funds, ETFs are traded on stock exchanges, just like individual stocks. This makes ETFs easy to buy and sell during trading hours, providing investors with greater flexibility and control over their investments.
Exchange-traded funds have been around for just over three decades, but in that time, they have become one of the most popular investment choices for individuals and institutional investors alike.
The first ETF, the SPDR S&P 500 ETF (SPY), was introduced in 1993 by State Street Global Advisors. This ETF tracked the S&P 500 index, which is made up of the 500 largest publicly traded companies in the United States. The SPY quickly became popular among investors, as it provided an easy and low-cost way to invest in a broad range of stocks.
Over the next few decades, ETFs continued to gain popularity and the number of ETFs available to investors rapidly expanded. By the end of the 2000s, there were over 1,000 ETFs available, covering a wide range of asset classes, including stocks, bonds, commodities, and real estate.
In recent years, ETFs have continued to evolve and innovate. For example, actively managed ETFs, which are managed by a portfolio manager rather than tracking a specific index, have become increasingly popular. Additionally, ETFs have expanded into new and exotic asset classes, such as cryptocurrencies.
Benefits of Investing in ETFs
- Diversification: ETFs allow investors to hold a diverse range of assets, reducing the risk of investing in a single stock or sector. This makes them a popular choice for investors who want to spread their money across different types of assets, such as stocks, bonds, and commodities.
- Low Cost: ETFs typically have lower fees than traditional mutual funds, which can make a big difference over the long-term. This is because ETFs are passively managed, meaning they simply track the performance of an underlying index, rather than actively trying to beat the market.
- Liquidity: ETFs can be bought and sold just like stocks, providing investors with greater flexibility and control over their investments. This can be particularly useful in volatile markets, where investors may need to quickly adjust their portfolios.
- Tax Efficiency: ETFs are structured in a way that can make them more tax-efficient than traditional mutual funds. This is because ETFs can be bought and sold in a tax-advantaged way, reducing the amount of capital gains taxes that investors may have to pay.
Considerations When Investing in ETFs
- Market Risk: As with any investment, there is always a risk that the underlying assets held by an ETF will decline in value.
- Management Style: While passively managed ETFs can be low cost, they may not always perform as well as actively managed funds. Investors should consider the management style of an ETF before investing, to determine whether it aligns with their investment goals and risk tolerance.
- Investment Objective: ETFs come in a wide range of styles and objectives, from broad-based stock and bond ETFs to more niche products that track specific sectors or commodities. Investors should carefully consider the investment objective of an ETF before investing, to ensure that it aligns with their financial goals and risk tolerance.
With their wide range of asset classes, low cost, and ease of trading, ETFs provide investors with a flexible and cost-effective way to invest in the markets.