Many experienced financial advisors recommend using exchange traded funds for the low costs and tax advantages.
There are plenty of advantages when trading ETFs, such as low cost, tax efficiency and easy tradability. But with the good traits also come some dangers such as trading and liquidity issues. Liquidity is one of the biggest concerns with ETF usage due to the flash crash of 2010, reports Dan Jamieson for InvestmentNews.
“Frankly, whether we’re dealing with larger portfolios or smaller ones, our focus is on steering clear of less desirable parts of the market,” Alex Cabot, analyst at Wiley Group said. “Avoiding illiquid ETFs is a basic element in that process.”
A broad-based ETF with plenty of assets under management is a good start for well-rounded, diversified stock market exposure. Advisors also suggest using a fund that has been trading for at least 3 years to ensure liquidity and avoid a fund closure. [Surveying S&P 500 Index ETFs]
“Especially in a taxable account, the last thing you want is an esoteric, thinly traded fund that a sponsor shuts down,” thus creating a tax liability, Scott Dunbar of Arnerich Massena Inc., said. [Checkpoints on How to Really Understand ETFs]
Another important factor to consider with ETF selection is looking at the underlying holdings. It is crucial that an investor or advisor looks at the stocks an ETF holds because there is a gap between the title of a fund and the actual companies that make up the index. The underlying components are an indicator of how liquid the fund is. [ETFs: Still the Industry Bargain They Used to Be?]
When an ETF is used properly, they can give investors positions in a portfolio of stocks or bonds that would be expensive and time consuming to build otherwise. They are also good for accessing corners of the market such as overseas stocks, commodities or currencies, at a fair price and with the ease of a single transaction. An advisor can help sift through the 1,268 or so ETFs currently trading.
Tisha Guerrero contributed to this article.