10 Reasons I Love to Invest in ETF’s
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?
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These are all great reasons to invest in ETFs. But, I have to say that my all-time favorite is the diversification factor. The great thing that I love about them is that, for not so much money, you can put you funds into one portfolio with a variety of different companies and industries. It’s hard to diversify your portfolio all by yourself, especially if you don’t know what you’re doing. This is what makes ETF diversification so attractive.
I have to agree with you that diversification is probably the #1 reason for using ETF’s. If you have less than $20,000 there’s probably no point in trying to diversify by yourself using individual stocks. You just don’t have enough purchasing power. With ETF’s though you could have a very diversified portfolio for $20k.
Very true – it’s easy diversification within the stock market asset class. Most importantly I love that it frees up more time for me to make more money and relax a bit… as if I actually relax, haha!
Yeah I don’t get the idea you relax much. You damn New Yorkers and your type A personalities give the rest of us a bad name.
Ha! Yeah, we’re pretty aggressive over here…
These are all great points! My problem with ETFs is that it leaves the door open to “trade” and try to time the market. Mutual Funds aren’t as susceptible to this and that is why, overall, I’d prefer MFs.
If I were to use them personally, it would also depend on the internal fee structure and past performance. But for the average Joe I don’t think it’s good to give them the ability to “trade.”
That is a good point, they do open up the possibility of trying to time the market and trading excessively.
ETF also let you take a view on the markets like index. Plus there are ETF for comodities like gold and oil whihc if you want to investment in them are simple ways to do via ETF
Shhhh…that is an upcoming post
It should be pointed out that all of these reasons could be reasons to invest in indexed mutual funds. The main difference being three things: 1) ETF’s can have smaller fees than some mutual funds (but not all and ETF’s will sometimes incur a transaction fee to sell/buy). 2) ETF’s are based on the market, while a mutual fund is based on NAV. 3) ETF’s can be slightly more tax efficient, especially if it is a share of a mutual fund. For active “traders,” who deal with a taxable brokerage account, there is a slight advantage to ETF’s. For an investor who believes in buy-and-hold and if you can find a similar mgmt fee, it’s sixes.
Yes, addressed in #5, 6 and 8. I do agree though that indexed mutual funds (providing you can avoid excessive management fees) are a suitable alternative to EFT’s.
Right on! I really live the diversification of ETFs. No more finding out one day that the individual stock you invested in missed earnings, or had a lawsuit filled against them and suffering a whack to the portfolio value. As you know, I invest only in ETFs, because of all the reasons you list here. Lower expenses, lower risk, and with such a high percentage of a stock’s price correlated to industry or even sector, I just don’t see the risk/reward trade-off being worth it. Thanks for making the list, it should help folks new to the (fairly new) world of ETFs too.
I know you love ETF’s and thought of you when I was writing this. Glad I didn’t miss anything. ETF’s have become extremely flexible in the past 19 years, with an ETF available to track darn near anything. I guess that should be #11
I have yet to start investing myself but I must say that as soon as I am able I will be investing largely into ETFs. I will most likely be solely investing in ETFs for a good portion of my life until I can build up enough capital to be properly diversified.
I’ll be looking forward to your post on how you bought your first ETF.
I like the diversification of ETFs most, as just about everyone here has said.
But then again the gambler in me believes that there are stocks that are undervalued, so I do have one particular stock now and am always researching good ones. But a broad market ETF should be the backbone, you can always allocate some money and use that as your “fun money” to use to buy individual stocks.
Using ETF’s as the core of your portfolio and then investing in individual stocks as the outliers is a common strategy. It gives you all the diversification and risk protection in the core with the chance for outsized returns from your individual stock selections. Plus it is a good way to have a safe portfolio while still satisfying the gambler inside
Thanks for the article. I think it’s very enlightening. Also, promotes the use of ETFs as a means of investment in the stock market. In my blog I’m doing the same. One aspect that is important to note is that with the use of ETF’s can be accessed a very good returns.
I say this because many people insist on the issue of diversification as central. This topic is doing much damage to long term personal savings. Highly diversified mutual funds, generating an average of 4% per year. All reports I’ve read, point out that with 4% a year, you can not save enough to have an adequate pension. The bad news is that 6% does not reach.
I’m promoting the idea that people will have to spend a little more time to manage their savings, investing properly. The ETF’s are tools to generate good returns without having to devote much time to follow up these inversionses. Congratulations.!
I am a stock trader, invested in mutual funds as well because I believe on “Don’t put all eggs in a bucket” philosophy. Recently, I added ETFs in my trading portfolio to extent my investment areas. However, I am new in ETFs investment. I am agree with your some points but these points are also same in stock and mutual funds like “Lowered Transaction Costs” and “Allows For Better Focus “.