Exchange-traded funds, or ETFs, are one of the most important and valuable products created for individual investors in recent years. ETFs offer many benefits and, if used wisely, are an excellent vehicle to achieve an investor’s investment goals. At VFS we refer to the professionals at Huxton Black for our clients ETF needs.
An exchange-traded fund is a basket of securities; like stocks, bonds, commodities or some combination of these that you can buy and sell through a broker. ETFs offer the best attributes of two popular assets: They have the diversification benefits of mutual funds while mimicking the ease with which stocks are traded.
Like any financial product, ETFs aren’t a one-size-fits-all solution. Evaluate them on their own merits, including management costs and commission fees (if any), how easily you can buy or sell them, and their
investment quality.
ALL TYPES OF ETFs
Market ETFs: Designed to track a particular index like the S&P 500 or NASDAQ
Bond ETFs: Designed to provide exposure to virtually every type of bond available; U.S. Treasury, corporate, municipal, international, high-yield and several more
Sector and industry ETFs: Designed to provide exposure to a particular industry, such as oil, pharmaceuticals, or high technology
Commodity ETFs: Designed to track the price of a commodity, such as gold, oil, or corn
Style ETFs: Designed to track an investment style or market capitalization focus, such as large-cap value or small-cap growth
Foreign market ETFs: Designed to track non-U.S. markets, such as Japan’s Nikkei Index or Hong Kong’s Hang Seng index
Inverse ETFs: Designed to profit from a decline in the underlying market or index
Exchange-traded notes: In essence, debt securities backed by the creditworthiness of the issuing bank; created to provide access to illiquid markets and have the added benefit of generating virtually no short-term capital gains taxes
Alternative investment ETFs: Innovative structures, such as ETFs that allow investors to trade volatility or gain exposure to a particular investment strategy, such as currency carry or covered call writing
MOST POPULAR ETFs USED
Smart Beta ETF:
Smart Beta ETFs track an underlying index which uses a rules-based approach to determine which stocks are included in an index. Smart Beta ETFs offer transparency, diversification and low cost—with an index methodology grounded in research-based insights that seeks to achieve a specific goal, such as strong risk-adjusted returns, consistent performance, income or low volatility.
Actively managed ETF:
An actively managed ETF is overseen by professional portfolio managers with a specific goal, such as outperforming a benchmark or achieving lower volatility than a benchmark. Since active managers are not required to follow a specific index, they may make changes to the fund’s allocation they deem appropriate based on changing market conditions. As a result, the return may be higher or lower than the return on the benchmark. Expense ratios of actively managed funds tend to be higher than passive ETFs but lower than traditional mutual funds.
PROS AND CONS OF EXCHANGE-TRADED FUNDS (ETFs)
PROS OF ETF INVESTMENT
Diversification: While it’s easy to think of diversification in the sense of the broad market verticals — stocks, bonds or a particular commodity, for example — ETFs also let investors diversify across horizontals, like industries. It would take a lot of money and effort to buy all the components of a particular basket, but with the click of a button, an ETF delivers those benefits to your portfolio.
Transparency: Anyone with internet access can search the price activity for a particular ETF on an exchange. In addition, a fund’s holdings are disclosed each day to the public, whereas that happens monthly or quarterly with mutual funds.
Tax benefits: Investors typically are taxed only upon selling the investment, whereas mutual funds incur such burdens over the course of the investment.
CONS OF ETF INVESTMENT
Trading costs: ETF costs may not end with the expense ratio. Because ETFs are exchange-traded, they may be subject to commission fees from online brokers. Many brokers have decided to drop their ETF commissions to zero, but not all have.
Any buyers for the ETF? As with any security, you’ll be at the whim of the current market prices when it comes time to sell, but ETFs that aren’t traded as frequently can be harder to unload.Risk the ETF will close: The primary reason this happens is that a fund hasn’t brought in enough assets to cover administrative costs. The biggest inconvenience of a shuttered ETF is that investors must sell sooner than they may have intended — and possibly at a loss. There’s also the annoyance of having to reinvest that money and the potential for an unexpected tax burden.
THE TAKEAWAY:
ETFs are a great way to invest for the long run, and their combination of long-term growth and low costs can make them a valuable tool in anyone's investing strategy. Going through the universe of ETFs can seem like a daunting task, which is why here at Volpe Financial Solutions we offer personalized portfolio review, followed by an investment plan that is tailored to each and every client. If ETFs end up being the best option for you, we will refer to Huxton Black for their professional expertise
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