Why All The Fuss Over Exchange-Traded Funds?

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Exchange-traded funds, or ETFs, are a relatively new development in the world of investment. It was not even 30 years ago, in 1989, when ETFs began. You might have heard people talking about their exchange-traded funds as a solid, safe investment—and indeed ETFs are. But what are they? Why are they a prudent investment? Perhaps most importantly, how do you start getting into investing in ETFs?

What is an ETF?

An exchange-traded fund allows consumers to invest in an entire market rather than just a portion of it. Basically, rather than picking stocks out of the S&P 500 or the Dow Jones Industrial Average, you’re betting that the entire market is a good investment. Historically speaking, this is true: The stock market is up two out of every three years, meaning that for long-term investment you can’t really do much better than a stock ETF that tracks a broad, diversified index.

[caption id="attachment_639663" align="aligncenter" width="640"]Source: Thinkstock Source: Thinkstock[/caption]

What are the benefits of an ETF?

In addition to being one of the safest bets, they also combine the best of both worlds. On one hand, you’re basically just picking one “stock” and going with it. Unlike mutual funds, which just have one value for each day, ETF values fluctuate throughout the day, meaning that you can trade at any time during the day. However, nested within that stock is an entire diverse portfolio. You don’t have to worry about managing an ETF much—the exchange is going to do that for you. This also leads to greater transparency when it comes to your fund; making ETFs the proverbial open book.

What’s more, ETFs are basically like index funds that cost a lot less. When it comes to keeping more of your money in the market working for you, ETFs really can’t be beat. Because ETFs aren’t actively managed (whatever is in the fund is in the fund), you’re not going to be paying a lot in the way of fees for someone to look after your money. Additionally, marketing and other expenses are generally low on ETFs.

Lastly, the tax benefits are also attractive. ETFs don’t generate much in the way of capital gains due to their rock bottom turnover rate. What does this mean? No capital gains, no capital gains tax.

Is an ETF for me?

While ETFs might sound like the greatest investment since the Dutch tulip bubble, they’re not for everyone. ETFs are mostly for:

  • People with a bunch of money to invest. You don’t need the general minimum of a mutual fund, but you should have a reasonable amount of money. Any “found” money can go into an ETF.
  • People in the market for the long term. This isn’t the place to stick your mortgage deposit if you’re looking to buy in 18 months.
  • People who aren’t looking to buy a little bit here and there every month. This is where you’re going to get hurt with fees in the long term.

Written by Nicholas Pell. The views expressed herein are not intended to serve as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell securities by FutureAdvisor. Differences in account size, timing of transactions and market conditions prevailing at the time of investment may lead to different results, and clients may lose money. Past performance is not indicative of future results.

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