There are always ups and downs in the market and individual stocks. Having a portion of your investment allocated in ETFs can help ease the volatility in your portfolio.
Exchange-Traded Funds blew up in popularity after their mass introduction in the early 2000s. And they continue to grow in popularity and the number of ETF’s. Today we have more ETFs than publicly traded companies. It has been great for investors as it offers low-cost options’ to invest, and now they are available in almost all sectors and cryptocurrency space.
Of course, no investment is perfect, and all ETF portfolios have their extensions and limitations too.
Diversification —
One of the main benefits of investing in the ETF is that it gives your portfolio instant diversification, which can help you minimise portfolio risk. With ETFs help, you can invest in specific markets and sectors. For example, suppose you wanna invest outside of your home country to get exposure to the outside market. In that case, you can buy an ETF that gives you exposure to the industry most suitable to your investment objective.
ETFs relationship to the market supply and demand —
Most of the time, the price of an ETF is tied to and, if not within proximity to the net asset value. And market forces don’t effect ETFs as much as they effect individual stocks as they’re structured differently from the stocks of a publicly-traded company.
There is a finite number of stocks available, and the stock price determines the market cap of that company. In contrast, the ETF construction model follows an open-ended fund structure so that the number of ETF units are not fixed and can expand and contract depending on the level of demand of the ETF itself.
Lower management cost —
An ETF is a passively managed fund instead of other actively managed investments. An actively managed fund has a fund manager that actively tries to outperform the benchmark. The actively managed fund typically involves a higher fee as their higher trading activities compared to the ETFs where the portfolio is balanced once every 3–6 months. Which the main reason why ETFs have low management fee and expense ratios.
Liquidity and transparency —
ETFs are considered highly liquid. You can buy and sell ETFs in most circumstances as long as the market is open. The market makers facilitate this by managing the buying and selling process while keeping the bid and offered price spread to the minimum.
In terms of transparency, ETFs, by nature, aims to track specific industries or classes of assets. The Etf manager must disclose the entire portfolio holdings to the public, which can help investors better understand their investments.
Accessibility across the market —
There are ETF’s for everything you need, such as stocks, bonds, real estate, crypto and many hybrid ETFs that offer a mix. Etf’s can also vary on how they target a particular class of assets. Some etf follows the small-caps stocks to gain potentially outsized return in the future. With the help of these ETFs, an investor can quickly get exposure to different market sectors. Instead of buying twenty stocks to diversify the portfolio, investors can buy two or three ETFs with different capital allocations to give the same diversification and save on brokerage fees.
CONS —
It’ll never actually match the index-
The management fee you pay on the ETFs means that your returns will never match the index returns. The buying and selling price, along with the capital allocation on the stocks, will effect your returns when compared against the market.
Volatility —
Despite the diversification provided by the all-etf portfolio, it doesn’t shield you from the market’s volatility. You can still suffer a loss during the brunt of the bear market, and the risk factor can increase in line with the specialisation of the ETF. A small-cap focused etf will likely be more volatile than a large-cap etf. For example, the fund tracking the electronic cars market will be more volatile than the S&P 500.
ETF’s are a cheap and efficient way to gain exposure in the market. Nonetheless, look carefully before you jump to a conclusion. Most ETFs invest in the narrow and potentially volatile sectors of the market. Do your own research about how much will it cost you to invest in the ETFs of your choosing over the long run. More often than not, you lose your etf advantage in paying periodic investment and brokerage fees.
You don’t have to choose between all or no ETF
There is no rule stating that you have to stick to all ETFs or no ETF. You should choose the strategy that makes sense to you. Not everyone will have the same investment goals as you.
If an all ETF portfolio fulfil your needs today, you should set up one. When your investment objective changes, so do your portfolio. If you are confident in taking on more risk than the market. Then it doesn’t make sense to keep increasing your all etf portfolio positions.
ETF definitely has certain advantages over other types of investment in certain cases. Don’t get caught up in the hype of having all ETF portfolio. Instead, pick each asset by comparing all suitable options to find the best investment for you. If you’re still unsure about your investments, speaking to a fee-only financial planner can help you gain clarity.
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