Exchange Traded Funds (ETFs) are a type of security that offer the ease and flexibility of stock trading with the diversification of mutual funds. This kind of best-of-both-worlds investing has a lot of potential for anyone looking to grow their money, but it’s important to understand exactly what you’re getting into. Here’s what you need to know about this investment vehicle and how it can fit into your financial plan:
An exchange traded fund is a basket of securities that usually tracks an underlying index. The underlying securities can be any type of asset, from stocks to bonds to precious metals to foreign currencies. Each ETF has its own unique ticker symbol.
For instance, the very first ETF ever created was the SPDR S&P 500 ETF (ticker symbol: SPY), which tracks the S&P 500 Index. This ETF corresponds generally to the price and yield performance of the S&P 500.
Because ETFs are made up of an assortment of securities and can track an underlying index, they are similar to mutual funds, which are also made up of a diverse mix of securities. Like a mutual fund, an ETF offers investors a diversified investment, which can protect them from market volatility. Even if one asset or asset class within the basket of ETF securities takes a nosedive, the other securities can help pick up the slack.
While ETFs share similarities with both mutual funds and stocks, there are some important differences, as well.
Unlike a mutual fund, you don’t actually own the underlying assets when you invest in an ETF. A financial services firm purchases those securities, and sells shares that track the value of the ETF. You, as the investor, own shares in the ETF. You don’t own the assets.
What that means for investors is that you can quickly and easily buy and sell your ETF shares, in the same way you can trade stocks. Mutual funds can only be bought and sold at the end of each trading day, whereas ETFs and stocks can be bought and sold throughout any trading day.
You can expect to pay an annual management fee for your ETF, generally charged as an expense ratio. This management fee tends to be lower than the fees charged by actively managed mutual funds, and even some passive index mutual funds. For instance, Unifimoney’s ETF portfolio annual advisory fee starts at only 0.15%.
Some ETF trading may also charge a commission, depending on which brokerage you use. This is similar to trading individual stocks, which often comes with a commission charge per trade. However, you can enjoy commission-free trading with Unifimoney, making it a convenient and economical choice for investors.
So if ETFs are as tradeable as stocks, why not just become a day trader instead? Trading stocks does not come with an advisory or management fee, potentially making it a less expensive option, depending on the commission you have to pay for day trading.
But trading individual stocks requires much more effort and money from investors looking to get the same level of diversification represented by an ETF. Investing in an ETF gives you an immediately diversified portfolio for the cost of a single share, whereas you would have to invest in many different individual stocks to recreate the index.
Additionally, since the ETF is set up to mimic an index, it will be rebalanced over time to continue tracking that index. An individual day trader would have to manually rebalance their investments to make sure they don’t become overinvested in any one asset or asset class. This is hardly something most people have time for.
You’ll also need to be prepared to give Uncle Sam his due in the form of taxes. Any gains you earn from ETFs will be taxed in the same manner as the underlying asset class. If you sell an ETF made up of stocks as the underlying asset classes, then you will be taxed the same way stocks are taxed. If you’ve owned the ETF for less than one year, you’ll pay the short-term capital gains tax; more than one year, you’ll pay long-term capital gains tax.
Since ETFs can be made up of any number of asset classes, there are a variety of ways that your ETF investments could affect your taxes. For instance, gains from selling an ETF made up of precious metals will be taxed differently from an ETF made up of energy commodities or another made up of equity dividends or yet another made up of cryptocurrency.
Though taxation of mutual funds is also based on the underlying assets within the fund, there are differences between how ETFs and mutual funds are taxed. No matter how long you have owned shares in a mutual fund, any capital gains you make through that mutual fund are taxed at the long-term capital gains rate.
ETFs are specifically designed to track an index, and there are a dizzying number of possibilities out there, from the sublime (such as the aforementioned SPY) to the ridiculous (such as Procure Space ETF [UFO], which invests in space-related tech firms).
But the average investor will generally do well to stick to an ETF that tracks a market index. Choosing the right ETF depends on what kind of market you’d like to emulate.
For instance, if you are looking for large-cap growth, you might invest in JPMorgan US Momentum Factor ETF (JMOM), which is comprised of stocks from large, growth-oriented U.S. companies, including Tesla, Amazon, and Microsoft, and is ranked #1 in large-cap growth ETFs.
If you’re interested in investing in technology stocks, you might choose SPDR® S&P Software & Services ETF (XSW), which is comprised of shares of technology and computer software companies, and is the top ranked technology ETF.
No matter what type of index you hope to track with your ETF investment, there are funds set up to follow that index and years of information available to let you know how the ETF has done over time as well as independent rankings of individual ETFs by market index.
Of course, don’t just look at historical returns. That’s partially because past performance is no guarantee of future returns. But it’s also a good idea to make sure you check the advisory or management fees of whatever ETF you’re interested in. You’d hate for high fees to eat up your returns.
ETFs have a low barrier to entry for new investors. You can buy and sell shares of ETFs using nearly any broker, provided you know the specific ticker symbol for the ETF you’re interested in. This is much like buying and selling stock through a broker.
However, for anyone too busy or overwhelmed to do their own ETF purchasing, an AI investment platform like Unifimoney’s Tenjin AI Auto-Invest platform can effortlessly get you invested in appropriate ETFs to both protect your investment from volatility while positioning you for maximum returns. The Smart Investing program through Unifimoney ensures that your money is invested in a diverse group of curated ETFs that provide you with the right balance of growth and portfolio volatility.
No matter what financial goals you have, investing in ETFs through Unifimoney is a convenient and economical way to reach those financial plans. With the diversification of mutual funds and the flexibility of day trading, ETFs give you the opportunity to broaden your investments while protecting you from volatility.
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The above does NOT constitute an offer, solicitation of an offer, nor advice to buy or sell specific securities. The opinions listed above are not the opinions of Unifimoney Inc. or Unifimoney RIA, Inc. but represent the opinions of independent contributors. These contributors may or may not hold positions in the stocks discussed. Investors should always independently research any stocks listed and form their own opinions, while recognizing that any investments made may lose value, are not bank guaranteed and are not FDIC insured.