Every once in a while, a new form of investing will hit the marketplace and prove to be so transformative that investors are left wondering how they were ever able to live without it. Mutual funds, for example, took the investment world by storm and saw extraordinary growth throughout the 1980s by allowing average investors to use professionally managed, well-diversified instruments that never before existed.
Exchange-traded funds – commonly known as ETFs – had a similar impact on investment portfolios as they quickly took root and rapidly grew in popularity just after the turn of the century. Although, like their mutual fund cousins, they can lend high levels of diversification to investors, a handful of characteristics separate ETFs from any other form of investment.
An ETF is an investment fund that is traded on an exchange rather than redeemed like a mutual fund. They can invest in a variety of different investment classes, including stocks, bonds, commodities, or nearly anything else that can be actively traded. From an average investor’s perspective, ETFs can be an extremely convenient way to gain a significant amount of diversification within a portfolio while still enjoying the cost efficiencies of – most commonly – passive investing.
Using ETFs In Your Portfolio
While ETFs are undoubtedly capable of conveniently tracking broad-based indices like the S&P 500, Russell 2000, or any one of the many other popular market indices, they truly shine with their ability to invest in highly specialized economic sectors and asset classes. Although you can achieve the same results by buying individual stocks or – to a lesser extent – mutual funds, ETFs open the entire spectrum of the investing world to those that require convenience without substituting function.
For instance, ETFs can easily integrate commodities like oil, derivatives like options, or a combination of the two through futures ETFs. For an investor who wants to diversify their portfolio beyond the common asset classes like large and small-cap stocks, fixed income, and cash equivalents, ETFs make it possible to purchase large swaths of specific economic sectors without spending the necessary time and resources to research individual positions.
From the typical investor’s perspective, it’s hard to find any significant drawbacks to using ETFs in your portfolio as long as they are used appropriately. They are convenient, cost-efficient, and excel in providing heightened diversification.
Of course, given the wide variety of investments ETFs can be used for, make sure to use ones that align well with your financial goals. In other words, if you are risk-averse and most comfortable sticking with the more commonly known asset classes, an ETF that can triple short a bear market might not be appropriate for you. That is a notion that is true of all types of investing and is in no way exclusive to ETFs.
Would you like to see how ETFs can better your current portfolio or need help with your financial plan? We’re here to help! Simply click here or call (763) 445-2772 to schedule a complimentary consultation today!