Investors are often looking for ways to diversify their portfolios, and one way to do that is with exchange-traded funds (ETFs). These are securities available on stock markets that work like stocks, since both have fluctuating prices and are publicly traded. Unlike stocks, ETFs track a specific financial instrument, like an index, currency, interest rate, or commodity.
ETFs are generally considered cost-effective ways to diversify an investment portfolio. Historically, ETFs are thought of as passive investments that track another asset or index; however, more actively traded funds are being introduced over time.
The most well-known ETFs track benchmark indices, including the S&P 500 and Nasdaq Composite Index, as well as foreign indices, such as the FTSE 100 (London) and Hang Seng (Hong Kong). Some monitor specialized indices, including those that track sectors, types of stocks (such as growth or momentum), and more.
Some of the newer, more actively-managed ETFs track more specialized investment groupings, such as companies with women in executive leadership, companies with no exposure to a specific country, and so on.
Beyond ETFs
ETFs aren’t the only type of exchange-traded product. Investors can also use exchange-traded notes (ETNs) and exchange-traded commodities (ETCs). While these products trade in a similar manner, they track different things.
ETNs, for instance, track debt or fixed-income products. Those who invest in an ETN get paid the return received from the index they track at a set maturity date.
ETCs give investors access to spot and derivative commodity markets, which can be complex to navigate. Investors who want exposure to gold, corn, wheat, and more can simply purchase an ETC that tracks the investment.
Taken together, ETFs, ETNs, and ETCs form a group of exchange-traded products (ETPs) that can be a useful tool to include in a diversified portfolio.
Benefits of ETFs and other ETPs
Generally speaking, ETFs are both liquid and cost effective. Unlike mutual funds, which may require a large upfront investment or have rules around when or how you can exit the investment, ETFs can be bought and sold like stocks. Many ETFs are set to passively track a benchmark; this may mean ETFs have lower fees than comparable mutual funds.
ETFs may also come with tax advantages that make them more attractive than mutual funds. Due to the way they’re structured, and the way they handle reinvestments, ETFs rarely take and distribute capital gains, which may make them more tax efficient than mutual funds.
ETFs also tend to be highly liquid; selling your shares can be as easy as selling a stock. Of course, the ease with which you can sell shares depends on the market for that particular fund. ETFs that track the S&P 500, for instance, will generally be more liquid than a specialized ETF with less open interest.
ETFs are one of the many investment tools Bogart Wealth advisors may use when building client portfolios. You may also encounter ETFs when selecting investments within your employer-sponsored retirement plan. If you have questions about ETFs, reach out to a Bogart Wealth advisor.
