…Whether you’re already an ETF investor or have just been hearing about them, you may be curious to know more or understand them better. This is a great conversation to have with your financial advisor. Here are five questions (and brief answers) to help you get started.
The comments above and below are excerpts from an article by Hollie Fagan (BlackRockBlog.com) which has been edited ([ ]) and abridged (…) to provide a fast & easy read.
1. What’s the difference between an ETF and a mutual fund?
ETFs and mutual funds have a lot in common: They’re both diversified, managed bundles of securities that are divided into shares, and bought and sold by investors. ETFs are traded on an exchange just like a stock and usually track an index; however, they’re also structured somewhat differently. These features mean they’re typically cheaper to own than mutual funds, through lower annual management fees and potential tax efficiency…
2. How do I use ETFs?
A key feature of ETFs is their versatility. Our Pulse survey found that the top ways investors use them are to increase diversification (53%), and gain exposures to broad market indexes (43%) and specific sectors (36%). What’s more, because there’s an ETF for almost any market sliver you can think of, many investors also look to ETFs as replacements for individual stocks (42%) and mutual funds (44%).
3. How might ETFs fit into an overall portfolio?
Think of ETFs as yet another powerful investment tool at your disposal, alongside mutual funds and other vehicles. As just one example, ETFs could be a cost effective way to build a diversified core portfolio, combined with actively managed mutual funds that target specific outcomes or manager skills. It’s ultimately about what you hope to achieve as an investor and getting the best value for your money.
4. Aren’t these risky?
Investors often use ETFs to mitigate risks in their portfolios through diversification. However, like mutual funds, they carry similar market risks to their underlying securities so they’ll be subject to forces such as interest rate changes, geopolitics and industry trends. So when you’re thinking about risk, it’s important not to shoot the messenger. It’s also important to know that ETFs aren’t exotic instruments: They operate within a well-functioning, well-tested infrastructure with a lot of oversight.
5. Are ETFs trading vehicles or buy-and-hold investments?
The answer is yes. You can easily trade them in your brokerage account (and they’re sometimes available commission-free) just as you would a stock, making it easy to express a short-term market conviction. However, there might be an even stronger case for ETFs long term, namely in the cost savings, which can really compound over time. Investor behavior bears that out. According to our survey, the average holding period for ETFs is about five years; and more than a third of ETF owners have held their investments for six years or longer.
Of course, the “right” way to build a portfolio depends on your particular goals. As more and more people turn to ETFs for a variety of uses, the best way to find out how they could work for you is to ask.