Mutual Funds have long been accepted as the preferred investment vehicle for investors who are looking to actively manage their stocks while strategizing about how to best play the stock market. For investors who prefer more predictable, safer returns with less daily maintenance, though, a vehicle called an Exchange Traded Fund, or ETF, may be a better fit.
ETFs, which have been around since the early 1990s but continue to gain traction in today’s market, are programmed to track and mirror the performance of stock indexes that are comprised of all different kinds of stocks. An ETF can be set to track the performance of an entire national economy, for example, or the performance of a physical commodity, like silver. There are even ETFs that represent the scope of a full index, like the Dow Jones, and track the movement of all of that index’s stocks as one body. Because of their wide range of applications, ETFs offer investors a great way to diversify their portfolios with a single investment for a mere fraction of the price and effort that it would take to track stocks independently.
To explain how an ETF works: say you wanted to start investing in the gold market. One way to accomplish this goal would be to purchase ten physical bars of gold and lock them away in a safe. However, a much simpler way to invest in gold would be to buy shares in an ETF called GLD, which tracks the market share of gold. Because ETFs are traded on stock exchanges globally, they possess some of the same appealing traits as shares: you can buy and sell ETFs from as little as one chain, you can see their accompanying order books, and you can see the real-time cost of these shares throughout the trading day. And like index funds, ETFs offer less portfolio turnover than more actively managed funds, which require daily or weekly maintenance and attention. By investing in the GLD ETF, you’d be entering a very promising and transparent market at a very low threshold and without much risk, which would mean that you could expect to reap the benefits of a booming gold market with relatively little chance for failure. It is this ease of use and transparency that make ETFs so viable and appealing to investors who care more about steady returns and passive management than playing fast and loose with the money that they’ve worked so hard to make.
Of course, as is the case with any investment vehicle, there are some aspects of ETFs that could be considered pitfalls. As a member of the Moneyweek team explains in this video, ETFs are rebalanced at the end of each trading day, which can cause the performance of your portfolio to quickly deviate from the index it is meant to be tracking if you are not paying enough attention. To avoid this issue from cropping up, beware of buying short or leveraged ETFs unless you understand the market beyond an intermediate level. Additionally, there are two types of what are known as Synthetic ETFs that you should absolutely not invest in unless you are an expert. Synthetic Stock ETFs are ETFs in which only some of the shares in a given index are purchased, not all, thereby rendering the EFT useless in tracking the movement of the original index. The second kind of Synthetic ETF to avoid is a Synthetic Commodity ETF, which does not buy any of the physical commodity in question (like gold bars), and, instead, tracks the price of that commodity by investing in future options that may never materialize. If you are just breaking into the world of Exchange Traded Funds and hoping to go it alone, it is best to stick with the basics and avoid these more complex ETFs.
Fundamentally, while there are dangers associated with every kind of investment, ETFs can provide you with a relatively safe, risk-free way to reap returns from stock markets all over the world. If you are looking to transition into retirement by dialing back on your stock maintenance, you should speak to your financial advisor about how ETFs can help give you the peace of mind you deserve as you move into this exciting new chapter of your life.