To be a successful investor, you have to do your due diligence on your investments. When it comes to picking stocks, if you don’t put the time in, you’re going to lose money. That’s a guarantee.
These days, time is a privilege that many of us don’t have. With careers, children, other responsibilities, who has time to research stocks? And with the aforementioned responsibilities taking the majority of our money, who can afford to pay someone to manage your investments?
With thousands of stocks to choose from and all the market jargon, investing in the stock market can be overwhelming and very confusing. In today’s world, investing is an almost necessity. So, where do us time-crunched, stressed adults park our money?
ETFs may be the answer.
What is an ETF?
ETF stands for Exchange Traded Fund. An ETF is basically a basket of stocks, bonds or other investments.
When you buy an ETF, you’re actually purchasing pieces several different stocks or investments. Recently, while listening to an investing podcast, I heard a great analogy that wonderfully explained ETFs.
Think of an ETF as a car dealership. If the cars were stocks, the dealership would be an ETF. Owning a stock is like owning a car. But when you own the dealership you own a piece of several vehicles.
This has several advantages.
The Advantages of ETFs
Arguably the greatest advantage of an ETF is the ability to mitigate risk.
When you buy a stock, you’re buying a piece of a company. What happens if that company goes under? You lose your investment. However, with an ETF you own a piece of several different companies, so your investment is not tied to the performance of one security.
An ETF also allows for instant diversification, since all of your eggs are not in one basket so to speak.
For example: let’s say you want to have exposure in the rising technology sector but are not sure technology stocks to buy. You could buy a technology ETF such as the Technology Select Sector SPDR Fund (XLK). This particular ETF would allow an investor to own such tech giants as Apple, Microsoft and Facebook.
There are ETFs available to take advantage of literally every sector and asset class. There are even inverse ETFs that go up when the market goes down.
An ETF will usually come with a prospectus, which is an overview of the portfolio holdings, risk profile, fees and past performance. When considering an ETF, ALWAYS read the prospectus.
ETFs versus Mutual Funds
ETFs are often compared to mutual funds. However, ETFs have some very distinct differences from mutual funds.
One great thing about ETFs is that they trade just like individual stocks. Like stocks, ETFs have ticker symbols and can be bought and sold during market hours, as opposed to mutual funds that can only be traded once per day after market hours.
Mutual funds are actively managed, so they also come with added costs. Commissions, distribution fees, exit fees and other operating expenses that come with mutual funds can greatly diminish returns. Many of these fees are hidden from monthly statements so they are never seen by investors.
The operating expenses for ETFs are substantially less than mutual funds. On average, the cost of ETF investments are about 75% less than mutual fund investments.
ETFs allow for diversification with less risk and less effort. If you want to put your money to work in the stock market but don’t know which stocks to buy, consider an exchange-traded fund.