Exchange-traded funds (ETFs) are a relative newcomer to the investment world. The first ETF’s were introduced in 1993 and in the 19 years following their numbers have skyrocketed. There is a good reason for this. ETF’s provide many benefits that you won’t get from traditional stock and mutual fund investing. If you haven’t considered adding ETF’s to your portfolio (or even using them exclusively), you will want to read the following 10 reasons why I love to invest in ETF’s.
- Better Diversification – Because the average investor often has a limited amount of resources it can be difficult for them to build a properly diversified portfolio. When you consider asset classes, geographic concerns, broad industries and company size its no wonder it can be difficult to properly diversify. Using ETF’s can provide instant diversification across any of these areas, providing a good base for your portfolio and reducing your overall risk.
- Improved Investing Knowledge – Because of the broad range of equities included in ETF’s you will need to become more knowledgeable about market indexes, risk profiles and overall portfolio management strategies. This will in turn make you a better investor over time and should result in better portfolio performance.
- Improved Performance – When you consider that over 50% of professional money managers cannot outperform the stock market its no wonder that individual investors often have problems with underperformance. To give your portfolio a boost while also reducing overall risk you could use a broad based ETF as a core holding. This strategy can improve the overall performance of your portfolio and let you sleep easier at night.
- Easy to Rebalancing – Rebalancing your portfolio is a wise thing to do at least quarterly. Run ups in the market call for profit taking and declines make for good buying opportunities. If you are holding individual equities this can sometimes present problems. By using ETF’s for your core portfolio it is easy to switch between asset classes, industries or geographies.
- Lowered Transaction Costs – Once you switch to ETF’s for your core holdings you will find that you make fewer trades, reducing the amount you pay in commissions. In addition, ETF’s typically have very small management fees. Your savings at a full commission broker could be substantial when using ETF’s as your core holdings.
- Easy to Monitor and Understand – As your portfolio grows it can become more difficult and time consuming to monitor and manage all of your holdings. An increased number of equities in your portfolio also brings increased complexity and additional investment decisions. Using ETF’s can decrease the time required to manage your portfolio and also decrease the complexity of your investment decisions.
- Allows For Better Focus – Every investor has industries and sectors they feel more comfortable with as well as those they may not like, but need to include for diversification of their portfolio. By using an ETF to diversify into those sectors you don’t necessarily want to research deeply you can focus better on your individual stock selections.
- Improved Tax Efficiency – If you hold all individual stocks in your portfolio you tend to generate more trading activity due to market changes, rebalancing and changing investment outlooks. This increased trading is bound to result in increased capital gains and with that increased taxes. Because they are very tax efficient, ETF’s can be a good part of your tax saving strategy in addition to being a great investment vehicle.
- Decreases Volatility – With individual stocks comes inevitable increased volatility. And the fewer stocks you hold the greater this volatility becomes. Because an ETF is a broad basket of stocks volatility is dramatically reduced.
- Advanced Investment Strategies – Once you include ETF’s as your core holdings it becomes easier to implement advanced investment strategies such as hedging, tax loss harvesting, advanced index investing and more.
Because ETF’s provide easy diversification, greater flexibility and decrease risk I feel it is worth the time to get to know your options regarding the use of ETF’s in your portfolio. Once you have a solid ETF strategy you are likely to find that your overall returns are not only better, but also more consistent, without wild swings that can come from individual stock holdings. In addition, the time savings from using ETF’s will allow you to focus better on your remaining stock portfolio as well as simplifying your occasional portfolio rebalancing. Overall the benefits to be gained from ETF investing are too numerous to overlook.
Are you currently using ETF’s as part of your portfolio? If you are do you agree with my assessment? And if you aren’t is it because you’ve looked into them and found them wanting or simply because you weren’t aware of all the benefits to be gained using an ETF strategy?