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 an ETF portfolio might be for you. If you are looking for a perfect ETF portfolio for you, check out our list of popular investment portfolios.
What is an ETF?
An ETF is an acronym for 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. Buying an ETF is just like buying an individual stock. You login to your favourite broker, find a ticker for the ETF you want to buy and execute a trade. What you are getting however is not a piece of one company but a piece of a whole professionally managed fund.
I love ETFs. I have two main portfolios in my investment strategy. One is a portfolio of individual stocks and the other is an all ETF, set it and forget it type of portfolio. There are, of course, downsides and risks to every investment vehicle but let’s talk about positives first.
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 treasuries. With only three trades, you can achieve an incredible level of diversification. To do the same with individual asset purchases would require a lot more trades. Keeping everything in balance after that is also a hassle because now you have to manage a much larger portfolio than having a portfolio with three ETFs, as an example.
2. Relatively low fees
When I was entering a career in finance back in the day, 2/20 fee structure was common. Funds would charge you 2% per year for just managing your money and then take 20% of profits. As you can imagine this cost investors a fortune. What’s worse, is that a large number of these funds did not produce decent results to justify such high fees.
With ETFs, you enjoy much lower 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. 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 other funds.
3. Easy to buy and sell
With an ETF, you can get in and out of an investment in seconds. Compare that to the process of withdrawing money from a mutual fund. Most don’t have easy online options so you have to call the bank or a mutual fund provider. If you are lucky they just let you withdraw your money and you have in three business days. Most of the time, however, the person on the other end will try to convince you that right now is the worst time to withdraw and that the your returns would be much better if you hold on. It could be true, of course, it can definitely prevent you from taking impulse decisions but the point is you are not in control.
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. This is not unique to ETFs as almost all legit funds are regulated.
5. The ability to profit in a bear market with inverse ETFs (Advanced)
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.
Keep in mind that leveraged ETFs are leveraged through the use options & not necessarily borrowed funds.
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. If there is an asset class out there then there is probably an ETF that invests in that asset which makes our lives a lot easier.
8. Easy way to own an index
One of the most popular ways to invest is to have a portfolio that mirrors a major index such as the S&P 500 or the Nasdaq 100, and others. However, it is hard to manage a portfolio with 100 or 500 stocks. Instead 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 the S&P 500.
9. Access to specialized strategies (Advanced)
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. 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.
Expand each one for more detailed description:
- 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 (Advanced)
Another advanced strategy involves trading volatility. Volatility simply means price fluctuations in the market. 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 fund manager without having to deal with high hedge fund or mutual fund fees? 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 gains tax. 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
Holding ETFs also gives you some tax advantages over mutual funds and hedge funds.
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 finding the best ETF portfolio for you. Here is a look at three of the most popular ETFs today.
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.
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%.
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 while technology stocks continue to deliver exceptional results.
Read related: Is tech overvalued? In 2021
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.