The exchange traded fund industry has been around for about two decades now, and there are several reasons why the business is thriving. Growing investor preference for passively managed portfolios has driven assets to ETFs as well as index funds.
“Index funds and ETFs give investors low-cost, tax-efficient access to many asset classes that once were available only through relatively pricey actively managed mutual funds,” Paul Merriman wrote for MarketWatch. [Using ETFs for Extra Cash]
The following reasons validate why ETFs have become many investors’ favorite investing tool:
- Diversification ETFs give investors exposure to a number of stocks, in one purchase. In turn, owning more stocks allows investors to increase return level, while mitigating risk.
- Low Cost The average cost of an ETF is significantly lower than those of mutual funds. This allows more of the principal to be used for generating returns, rather than paying brokerage fees. And for those with internal operating costs, they too are lower per transaction than other funds available. Some ETFs allow for free trades, so check with the brokerage firm to see if opening an in-house account is worthwhile. [ETF Fees: Competition is a Good Thing]
- Tax treatment The taxation on an ETF benefits from the lower turnover seen in these funds. In contrast to an actively managed fund, an ETF does not hit all shareholders with taxation simply because a manager sold a position in a stock the fund has held for some time
- Transparency The ability to know what the fund holds in real time is unique to ETFs. ETFs disclose all stocks held at any time of the day. Basically, you know what you’re investing in, and usually it is an entire index. This also gives investors control over their investments. The direct investment into an asset class or sector is known from the beginning.
- Flexibility Custom-fitted for strategy ETFs are flexible for a buy-and-hold strategy and can be used for asset allocation. Since they are flexible they are often used as satellite holdings. Plus, the ease of the trade allows day traders to use them seamlessly. [Build a Diversified Investment Portfolio with Just 3 ETFs]
Tisha Guerrero contributed to this article.