We are always on the lookout for a smarter way to invest! Then you will want to take a look at ETFs or exchange-traded funds. You may have heard of ETFs. However, you may not know all the fantastic benefits of ETFs vs mutual funds or any other fund for that matter. Here, we will explain what exactly an ETF is and why you should create an ETF portfolio. If you are looking for a perfect ETF portfolio for you, check out our 3-Step guide.
What is an ETF?
An ETF is also known as an exchange-traded fund. An ETF is a bundle of investments that trades like a stock. With an ETF, you will be able to simplify your investing. As you will see, ETFs are available in several different variations that give you more ways to diversify your portfolio.
15 Advantages of using ETFs vs mutual funds to build your portfolio
Here’s a look at the top 15 advantages of ETFs that can help you get more from your portfolio.
1) Instant diversification
With an ETF, you can quickly diversify your portfolio. For instance, you can buy one ETF representing a bundle of value stocks, one ETF that represents a bundle of growth stocks, and one ETF that represents long-term treasures. With only three trades, you can have an incredible level of diversification.
2) Low fees
With ETFs, you enjoy potentially lower expense ratio fees than purchasing a mutual fund or participating in some other investment management fund. Typically, ETFs will require you to pay a management fee of under 1% per year. In some cases, you can pay as little as .1% per year. Over 10 or 20 years, low ETF management fees help you compound your returns better. That’s one of the biggest benefits of constructing with ETFs vs mutual funds.
3) Easy to buy and sell
With an ETF, you can get into and out of an investment in seconds. Compare that to a mutual fund where you have to wait until the end of the day to lock in your trade or get out of a trade. ETFs can come in handy during fast-moving markets.
An ETF is managed by a team that has to satisfy a number of regulatory filings. Also, all ETFs will have a prospectus that will show you how the fund is managed, the funds holdings, management fees, and rebalancing policy. Therefore, owning an ETF can give you peace of mind.
5) The ability to profit in a bear market with inverse ETFs
Many people think that the only way to profit in a down market is to short stocks. While this is extremely risky, shorting stocks is not the only way to profit in a falling market. ETFs also offer what are known as inverse funds. These funds go up in price when certain assets or indexes go down. For instance, the ProSHares S&P 500 Inverse ETF (SH) goes up 1% for every 1% the S&P 500 goes down. If you don’t want to short stocks, then an inverse ETF is an excellent trading option.
6) Easy ability to use leverage (Advanced. Not recommended)
What to get more out of a trade? Then you can take advantage of leveraged ETFs that can be used for intraday trading. There are a number of companies that offer leveraged ETFs that can give you up to 300% leverage up or down. Leveraged ETFs are great for fast moving markets. However, they are only recommended for experienced traders with a trading portfolio of at least $25,000. Here are some top leveraged ETFs to consider:
- TQQQ – ProShares UltraPro QQQ X3
- QLD – ProShares Ultra QQQ X2
- SSO – Proshares Ultra SPY X2
Although not recommended, this provides an example how versatile ETFs vs. mutual funds can be.
7) Easy to trade commodities with ETFs vs mutual funds
If you are looking to trade gold and silver, then you don’t need to actually buy gold and silver bars or trade futures contracts. You can actually buy a gold or a silver ETF that moves with the precious metals market. You can also find ETFs that trade with other commodities such as oil, copper, natural gas, platinum, and more.
8) Easy way to own an index
One of the smartest ways to invest is to actually have a portfolio that mirrors a major index such as the S&P 500 or the Nasdaq 100. However, it is hard to manage a portfolio with 100 or 500 stocks. However, you can mirror the performance of almost any index with an index ETF. Yes, with one trade, your portfolio can track the S&P 500 with super low management fees. When comparing ETFs vs. mutual funds, both options offer great index tracking solutions but ETF can do it much easier.
Consider SPY, one of the most popular ETFs that tracks S&P 500.
9) Access to specialized strategies
Looking to trade a specialized trading strategy? You don’t need to do lots of trading or complicated math. There are a number of specialized ETFs that will mirror a number of trading strategies. Here are some popular strategies that your portfolio can mimic with the purchase of one ETF:
- Covered Calls
- Seasonal Rotation
- Trend Following
- Dividend Investing
- Target date investing
10) Ability to easily invest in a sector
Want to invest in one particular sector in the market. Usually that would involve buying 10 or 20 stocks in that sector. The good news is that you can purchase what are known as Sector ETFs that allow you to get exposure to one sector of the market with just one ETF. The Sector SPDR list allows you to invest in the biggest sectors of the market. Here’s a look at the currently available Sector SPDR ETFs:
- XLB – SPDR Select Materials ETF
- XLC – SPDR Select Communications ETF
- XLE – SPDR Select Energy ETF
- XLF- SPDR Select Financials ETF
- XLI – SPDR Select Industrials ETF
- XLK – SPDR Select Technology ETF
- XLP – SPDR Select Consumer Staples ETF
- XLU – SPDR Select Utilities ETF
- XLV – SPDR Select Healthcare ETF
- XLY – SPDR Select Consumer Discretionary ETF
11) Ability to trade volatility
One of the most exciting trades that you can make is trading volatility. When the market begins to move down, the market volatility moves up. There are a couple of ETFs that allow you to profit from market volatility. These volatility ETFs can make an excellent short term hedge in potential market crashes or bear markets. Here’s a look at some popular volatility ETFs:
- VIXY – Proshares Vix Short Term Futures ETF
- VIXM – Proshares Vix Mid Term Futures ETF
12) Ability to trade currencies
You don’t need to open a Forex account in order to trade currencies. There are several ETFs that will allow you to invest in the currency of a particular country without having to deal with currency pairs or dangerous leverage. Whether you want to invest in the U.S. Dollar or the Japanese Yen, you can do it with one trade.
13) Ability to take advantage of active trading with Active Managed ETFs
Have you ever wanted your money managed by an active trader without having to deal with high hedge fund or mutual fund fees? Now you can with actively managed funds. With active managed funds, a portfolio manager will make trades on your behalf. These active ETFs have relatively low management fees and can sometimes lead to incredible gains.
14) Instant Rebalancing
If you buy individual stocks, you will have to rebalance your position in stocks that move up or down dramatically. Also, there will be times when you will want to add and remove individual stocks to meet your investing goals. This can cost you time and also force you to deal with capital tax gains. ETFs will automatically rebalance the holdings in the fund. Typically, an ETF will automatically rebalance the portfolio for you each quarter, every six months or once per year. However, portfolios consisting of multiple ETFs will still have to be rebalanced but because some portfolios can be constructed with as little as 2 ETFs, it is a lot easier to do.
15) Tax advantages over investing in funds
Holding ETFs also gives you some big tax advantages over mutual funds and hedge funds. With an ETF, you only have to contend with capital gains taxes after you sell your position. With mutual funds and hedge funds, you will have to deal with capital gains tax each time a trade is closed at the fund.
Some ETF examples to consider for your portfolio
Now that you know all the great advantages that ETFs offer, you may be interested in getting started with your own ETF purchase. Here is a look at three of the top ETFs available:
1) SPDR S&P 500 ETF (SPY)
The SPDR S&P 500 ETF (SPY) is the most popular ETF in the world. This ETF mirrors the performance of the S&P 500 index. With a low expense ratio of just 0.0945%, this ETF is a great way to invest in the broad market.
2) Invesco Nasdaq 100 ETF (QQQ)
If you want to take advantage of the continuing growth of tech stocks, then you will want to consider the Invesco Nasdaq 100 ETF (QQQ). This ETF mirrors the performance of the top 100 stocks in the Nasdaq by market capitalization. The expense ratio on this ETF is an excellent .20%.
3) Ark Invest Ark Innovation ETF (ARKK)
The Ark Innovation ETF (ARKK) is an actively managed ETF that invests in innovative companies in a variety of high growth sectors. Managed by superstar investor Cathie Woods, the Ark Innovation ETF returned an astounding 152.5% in 2020 and had an annualized return of 52.6% from 2018 to 2020. Yes, the expense ratio is higher at .75%. However, this active ETF is one of the best performers out there.
Getting started with ETFs
ETFs are a great way to get some diversification and unique strategies in your portfolio with one trade. You can get started by research ETFs online and checking to see what ETFs are available on your trading platform. With the right research, you will find the perfect mix of ETFs for your portfolio and investing goals. To get started with a perfect ETF portfolio for you check out our portfolio guide here.