The investment world swears by the fact that investing in exchange traded funds (ETFs) is a fantastic option for large and small investors alike. Taking the investing world by storm and trading live on stock exchanges, ETFs are a popular choice when it comes to investment portfolio diversification. However, what often leaves investors wondering, especially the ones beginning their investing profiles, are the different ways to invest in ETFs and apt strategies to invest in ETFs.
Let’s dig in to get some clarity-
What are ETFs?
There are two directions to understand ETFs- Firstly, consider ETFs to be a collection of various securities- stocks, bonds, commodities etc. and secondly, recall all that you know about mutual funds, as ETFs are in many ways similar to mutual funds.
We can define ETFs as a basket of securities holding various underlying assets and trading on a stock exchange, just like a regular stock. They undergo price fluctuations as they are bought and sold and offer low expense ratios with fewer broker commissions (relative to stocks).
You can address ETFs as index funds that trade like stocks.
Types of ETFs
ETFs are primarily used to generate income, hedge/ partly offset risk in an investor's portfolio, facilitate speculation and price movements. The below table outline the various types of ETFs-
Why Should You Invest in ETFs?
Researchers opine that ETFs began trading over a couple of decades ago but have been gaining in popularity against more mature mutual funds. Moreover, the money invested in ETFs has increased massively over the years and investors presently have a hoard of options to choose from.
So why this growth? Why do investors like ETFs?
- ETFs have low fees, compared to conventional mutual funds.
- They are more tax efficient viz a viz Mutual funds as one they create and redeem units, and second they are passively managed which leads to fewer transaction.
- ETFs provide an effective way to invest in a particular part of the bond or stock market.
- ETFs can be purchased or sold at any time during the trading hours of a day, just like regular stocks on a stock exchange.
- They are a great way to diversify an existing investing portfolio.
Ways & Strategies to Invest in an ETF
Ideally, ETFs trade via online brokers and traditional broker-dealers. In today’s contemporary world, even robo-advisors make use of ETFs in their investment products.
Below are the ways to invest in an ETF-
- ETFs require an investor to have a brokerage account.
- An investor can buy or sell ETF units via the broker using a telephonic mode/ positioning an order on the trading terminal (online)
- Each ETF circulates an annual expense ratio, indicating the percentage of the total fund assets pertaining to the costs that the ETF incurs annually. Investors should pay extra attention to this- as smaller expense ratios denote more money in the investor’s pocket.
- Owning more ETFs does not mean that an investing portfolio is a diversified one, as they might hold similar investments. This is why an investor should look for ETFs that pertain to different categories. For instance, tap ETFs from different asset classes like bonds, real estate, stocks and alternate investments.
- If a portfolio has risk exposure to a certain variety of market sectors, buying or short selling ETFs is a terrific way to hedge against market and investing risks.
- Purchasing shares in a foreign exchange traded funds helps in gaining coverage to international markets, an easy way to hedge and gain country-specific exposure.
- In the dynamic business world, there will always be certain industries that show potential growth or even a decline. ETFs of these, if purchased, will enable an investor to leverage the exposure of an industry as a whole.
- ETFs should be considered in the periods of excess cash flow. The extra money can be used to purchase an ETF that generates an opportunity for earning a potential return. What’s interesting is the fact that ETFs can be easily liquefied with one single trade in periods of cash flow deficit.
Besides these, experts believe that in a long-term based investing strategy situation, investors should purchase particular ETFs to bridge the gap in their diversified portfolios. On the other side, in a short-term investing scenario, ETFs can be used to hedge positions.
There is no doubt about the fact that the ETF market is growing and is here to stay. They can be valuable building blocks of an investment portfolio with the potential to bring both growth and income. The trick is to keep costs low and hunt for ETFs that best fit to an investor’s investing strategy.