Investing in today’s economy has evolved tremendously over the last decade. With advancements in financial technology and the growth of the Internet in general, the financial markets have become more accessible today than ever before.
Exchange Traded Funds (ETFs)
Growing financial markets entice new product creation and one of the more recent products is an ETF or an Exchange-Traded Fund. Having many of the same characteristics of a mutual fund, this is traded on the exchanges and behaves similarly to a stock with minute by minute price movements.
Difference Between an ETF and a Mutual Fund
As stated, an ETF has similar characteristics to that of a mutual fund in that it mimics an index or underlying asset. However, some of the differences include how it works. With a mutual fund, some funds require a minimum investment amount and only let you enter and exit as described in the prospectus. With an ETF, there are no minimum requirements and you can enter and exit how you see fit.
Secondly, when trading an ETF you are actually trading shares, whereas with a mutual fund you are contributing to the pool of assets and your money is being used to rebalance the portfolio. Some mutual funds will limit when you can enter due to frictional costs.
Lastly, mutual funds are typically priced at the end of the day whereas, with an ETF, the price is changing constantly like a stock.
Are ETFs a Better Investment Than Stocks?
Many individuals ask if an ETF is better then a stock, while it varies on an individual level, here are a few benefits that an ETF will have that equities do not. The first one is that company-specific risk is limited. When you invest in an individual equity, you add company specific risk to your portfolio, but when you add an ETF that tracks a sector or index, you have a limited company-specific risk.
Another benefit to an ETF is it is managed with a fund manager. This ensures that your ETF products are reacting and performing as it should. With a stock, you have to watch the company’s performance yourself and be willing to study and understand what you are investing in at the company level.
It’s difficult to have a flat statement saying one is better than the other because everyone has different investment objectives. Each has their own benefits and it is up to you to understand what your portfolio requires.
Are ETFs Safe?
As a general rule, yes, ETFs are a proven product that appears to be safe and sturdy. However, you cannot take for granted that an ETF is safe, even the popular ones such as the SPY. It is prudent that you as an investor to complete your own research and understand if the ETF is aligned with your financial objectives.
Overall, ETFs are a wonderful way to access certain areas of the market without taking on risks such as company-specific risk. You can find ETFs that track an index or market sector, allowing you to diversify portions of your holdings. ETFs should still be researched and reviewed like any investment and should you still have questions, contact your financial advisor.