An Introduction to ETFs

Successfully investing in the stock market takes time. Time to research companies, time to research the latest news updates/market trends and time to do actual trading during market hours. To be a successful investor, you have to be a self-starter and you have to do your due diligence on your investments. If you don’t put the time in, you’re going to lose money. For most of us, time is a privilege that we don’t have. With full-time jobs, kids, homes and other responsibilities, who has time to research stocks? And with the aforementioned responsibilities taking the majority of our money, who can afford to pay someone to manage investments? These days, investing has become an almost necessity, so where do us time-crunched people park our money? ETFs may be the answer.

What is an ETF?

ETF stands for Exchange Traded Fund. An ETF is basically a basket of stocks, bonds or other investments. When you buy an ETF, you are actually purchasing pieces several different stocks or investments. Recently, while listening to an investing podcast (yes, I’m a nerd like that), I heard a great analogy that wonderfully explained ETFs. Think of an ETF as a car dealership. If the cars were stocks, the dealership would be an ETF. Owning a stock is like owning a car. But when you own the dealership you own a piece of several vehicles. This can have several advantages.

The advantages of ETFs

Arguably the greatest advantage of an ETF is the ability to mitigate risk. When you buy a stock, you’re buying a piece of a company. What happens if that company goes under? You lose your investment. However, with an ETF you own a piece of several different companies, so your investment is not tied to the performance of one security. An ETF also allows for instant diversification since all of your eggs are not in one basket so to speak. For example, let’s say you want to have exposure in the rising technology sector but are not sure technology stocks to buy. You could buy a technology ETF such as the Technology Select Sector SPDR Fund (XLK). This particular ETF would allow an investor to own such tech giants as Apple, Microsoft and Facebook. There are ETFs available to take advantage of literally every sector and asset class. There are even inverse ETFs that go up when the market goes down. An ETF will usually come with a prospectus, which is an overview of the portfolio holdings, risk profile, fees and past performance. When considering an ETF, reading the prospectus is a must.

ETFs versus mutual funds

ETFs are commonly compared to mutual funds. Like ETFs, mutual funds are also made up of several stocks or investments. However, ETFs have some distinct differences from mutual funds. One great thing about ETFs is that they trade just like individual stocks. Like stocks, ETFs have ticker symbols and can be bought and sold during market hours, as opposed to mutual funds that can only be traded once per day after market hours. Mutual funds are actively managed, so they come with added costs. Commissions, distribution fees, exit fees and other operating expenses that come with mutual funds can greatly diminish returns. Many of these fees are hidden from monthly statements so they are never seen by investors. The operating expenses for ETFs are substantially less than mutual funds. On average, the cost of ETF investments are about 75% less than mutual fund investments.

With thousands of stocks to choose from, investing in the stock market can definitely be daunting. ETFs are great investment vehicles for those who want to manage their investments but don’t have the time to constantly research or trade individual stocks. ETFs allow for diversification with less risk and less effort. If you want to put your money to work in the stock market but don’t know which stocks to buy, consider an exchange-traded fund.

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