8 Reasons to Consider Investing in ETFs

When it comes to investment options, it is easy for newcomers to investing to feel overwhelmed by the options available to them. The good news is that there are several types of investments that can help new investors find their feet and start growing their money with just a small amount of capital investment and risk. 

ETFs, or exchange-traded funds, are a type of investment that experts regularly recommend to new investors, and for good reason. In this article, we will break down what an ETF is, how ETFs differ from other similar types of investments, and why a new investor should consider ETFs as an investment choice. 

What is an ETF?

ETFs are a type of investment fund and exchange-traded product that trades on an exchange in a similar way to stocks. How an ETF works is fairly simple. In basic terms, ETFs give investors the ability to buy or sell a group, or basket, of assets without the need to purchase each asset individually. The fund provider of an ETF designs an ETF to track the performance of their assets within their basket. That provider then sells shares to that fund to investors who own a portion of the ETF without owning any of the underlying assets within it. ETFs are designed to track the value of the underlying asset within the basket and they trade at market-determined prices that typically differ from the individual assets. 

ETFs are very similar to mutual funds as both ETFs and mutual funds function as a collection of currencies, bonds, stocks, and other assets such as gold bars. Just like mutual funds, ETFs are an excellent vehicle of diversification, giving investors access to a range of different assets and stocks. Due to this diversity, both of these investment options also have the benefit of being less risky than other types of investment. However, while there are some similarities between these two types of investment, investors should also look at the difference between mutual fund and ETF before they decide which one to choose. Companies like Weathsimple, who have a team of expert financial advisors on-hand to help businesses and individuals make the most of their investments, are well suited to offer advice on which kind of investment would be best suited to individual investors and help them make sound financial decisions.  

Liquidity and Why to Choose an ETF over Mutual Funds 

One of the key differences between an ETF and a mutual fund, and also the first reason why people should consider investing in ETFs, is the liquidity that ETFs offer investors. 

Liquidity, or the ability to convert assets into cash without losing money against the market price, is important for new investors as it offers a safety net that allows investors easy access to their capital should they need it. Liquidity is also important for new investors as it determines how quickly an investor can open and close positions. Unlike mutual stocks, which can only be traded at the close of trade, ETFs can be traded throughout the day just like stocks. 

ETFs also allow for frequent trading, which means that savvy investors can follow their investments throughout the day and jump in or out of positions should they see a good reason for it. This liquidity makes ETFs invaluable for investors with a small amount of capital as they have the ability to exit a losing investment immediately and thus preserve their capital. 

ETFs Are Extremely Cost Efficient

The second reason that ETFs are a popular investment option is that they are an extremely cost-efficient investment because, unlike mutual funds, ETFs are not actively managed. This means that there are fewer management fees associated with owning ETFs, making them an affordable option for young investors. ETFs also count as a single transaction during trading, further reducing commission fees for investors looking to save money where they can.

Variety is the Spice of Life

Thanks to the popularity of ETFs, in 2019 the number of ETFs worldwide numbered over 7000 with the inflow from the market exceeding 320 billion USD. The sheer variety of ETFs that are available to investors is a key reason why so many young investors choose this investment route. 

Some of the common types of ETFs include broad-market ETFs which track indexes that cover a large part of the stock market; sector ETFs that specialize in a particular sector of the market; style ETFs that focus on either value stocks or growth; currency ETFs which are designed to let investors profit off of moves in foreign currency values compared to the US dollar; and commodity ETFs which offer exposure to commodity markets, ideal for investors looking to diversify. 

ETFs Are a Great Tool for Diversification

Thanks to the huge variety of ETFs available to investors, ETFs are a great vehicle for diversification. Diversification, a strategy that aims to minimize the risk of investing by spreading out an investor’s money into a variety of assets to avoid big losses, is something that most experts recommend for investors of all levels but is particularly important for young investors with a small amount of capital. This is because, aside from minimizing risk, diversification also exposes new investors to more opportunities for returns and offers higher returns in the long-term. 

Additionally, and most importantly, diversification allows investors to hedge against market volatility. So, while there is some debate about whether too much diversification can be bad for investors,  diversification remains an invaluable tool for young investors looking to grow their portfolio, especially during adverse market cycles. 

ETFs Are More Tax Efficient than Mutual Funds

When it comes to tax efficiency, ETFs are often referred to as tax-friendly investments as they typically generate fewer tax liabilities than traditional mutual funds. This is because ETFs are index funds, which means that they have very little turnover and thus amass fewer capital gains than something like an actively managed mutual fund would. Also, due to the way ETFs are structured, the taxes for the holder are minimized due to there being fewer taxable events. 

ETFs Allow for Active or Passive Investing, and Everything In-between

ETFs are a popular investment tool because they allow investors the ability to trade passively as well as actively, or they can choose a mix of both styles. 

Passive investing, which is also referred to as a buy-and-hold strategy, is a popular choice among ETF investors. The goal of passive investing is to build a portfolio that mimics one or more market indexes to slowly grow an investment while keeping risk and management fees at a minimum. Passive investing is a strategy commonly used by newcomers to investing as it is more tax-efficient as well as cheaper and less complex than active trading.  

Passive investing does not focus on short-term price fluctuations or market timing, but rather relies on the assumption that the market will post positive returns over time. Because passive investing doesn’t aim to ever beat the market, the returns on a passive investment are typically lower than on active investments, however, there is less risk involved with this type of investment. 

Active investing, on the other hand, is a more hands-on approach to investing where the goal is to beat the stock market’s average returns and take advantage of short-term price fluctuations. This style of investing is more suited to experienced investors as it requires a more in-depth knowledge of the stock market and the intricacies of trading. ETFs are a fantastic tool for active investing as they can incorporate a variety of active trading strategies including sector rotation, buying on margin, market timing, and short selling. 

In terms of passive investing, ETFs offer investors the benefits of a passively managed investment while also offering them the flexibility to withdraw their investment at any time. 

ETFs Lower the Barrier of Entry for Investing

ETFs are, for the most part, simple in structure and easy to understand, which make them the perfect tool for new investors looking to enter the field. By using ETFs, young investors can use a passive investment style to learn the intricacies of the financial market and gradually move over to a more active style as they gain experience. 

Thanks to the variety of ETFs available, young investors can diversify their portfolios easily while also exposing themselves to a range of markets to find the best fit for their investing style. This range also means that young investors do not require a huge amount of capital to diversify, which means more security while they learn the ropes. 

Like Stocks, ETFs Offer Immediate Dividends

ETFs distribute dividends every quarter by holding all of the dividends paid by underlying stocks during that period and then paying them to shareholders on a pro-rata basis either in the form of cash or additional shares of the ETF. This means that, unlike in the case of mutual funds which often have longer payout periods, investors can look forward to regular payouts, giving them more chances to invest in other ETFs or other investment vehicles. 

Thanks to their simplicity, flexibility, low-risk factor, and relatively low cost of entry, ETFs offer young investors the perfect opportunity to learn the ins and outs of investing in a relatively low-risk way. 

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