When we think about investing diversification & risk reduction are paramount. That’s why at Investing Thrill we are big fan of ETF …. They guarantee both of them keeping management costs at minimum and much more!!
But what is ETF? What does it mean?
ETF stands for Exchange Traded Funds and they are instruments which track an index. Most ETFs are passive instruments, which means they aim to replicate the performance of the underlying index, rather than outperform it. Indices can be country or region specific and based on emerging markets, developed markets, fixed income and many other asset classes. These instruments give investors instant diversification as one unit represents an investment in multiple companies and sectors. ETFs are listed on-exchange and are traded like shares. Market makers are committed to provide two-way prices throughout the trading day.
Here are the reasons why we suggest you to invest in ETF today:
1) Better Performance
In general mutual funds give broad diversification, pooled costs and daily liquidity for a limited cost.
You can get those particular benefits with an actively managed mutual fund just as well as an ETF. However, time and time again it has been shown that active management does not perform well enough to overcome its additional costs, particularly over the long term and even more so in a taxable account. At 10 years, an index fund is outperforming 80%+ of its peers … just consider the benefits on an even longer time horizon. So when you invest in index funds, over the long run you can expect higher returns than those who pick mutual funds.
2) Lower Costs
Costs matter, and especially over the long run, they matter a lot … they basically make you a millionaire or not. The main reason index funds outperform actively managed mutual funds is that they have dramatically lower costs. Your expense ratio is likely to be only 1/10th that of an actively managed fund (0.02-0.2% versus 0.5-2%.) On top of this delta, there are additional hidden costs: commissions and bid-ask spreads that come from the most actively managed funds. So it’s a no brainer…
3) Less Risky
Index ETFs are among the most diversified and liquid securities traded on the major stock exchanges. As explained before these instruments give investors instant diversification as one unit represents an investment in multiple companies and sectors … which means to reduce the risk.
On top of this … Not only you get to avoid taking uncompensated risk with individual securities, but you also get to avoid ‘management’ risk. This is the risk that your manager, as human being, is subject to mistakes. When you invest in actively managed mutual funds, you’re always left to wonder whether the cause of a portfolio underperformance is just cyclical or the manager fault …
4) Less Time-Consuming
Another important benefit is that it takes dramatically less time to invest in ETF.
When you invest in index funds you don’t have to spend any time at all researching stocks or following companies. You don’t have to read the Wall Street Journal. All that information is simply un-actionable … and to get it, it’s a waste of your precious time.
For ETF the portfolio construction process is very simple. If you want to invest in REITs, you can simply invest part of the money into a REIT Index Fund. Done. Need international stocks? Add an international fund. Corporate bonds? There’s a corporate bond index fund. No worries about overlap with other holdings. You know what’s in the fund just by reading the fund name.
Transparency is another important side effect … Components of the underlying are fully visible to the investor. Issuers produce a factsheet for their ETFs which state what investors are being exposed to. Tracking performance is also published and easy to monitor!!
5) More Tax-efficient
An index fund portfolio is generally much more tax-efficient than an actively managed portfolio. The turnover is lower, so there are fewer capital gains distributions, particularly with a broadly diversified index fund, such as the total market funds. Theoretically the turnover is close to 0% … In actuality, it’s about 4%. But if you consider that the average mutual fund turnover is 85% …
Summarizing … Index ETFs are among the best performing, most diversified, liquid, and low-cost securities traded on the major stock exchanges. In fact, the largest ETF providers are also among the largest global asset managers, providing a measure of financial security.
Leading investors, such as Warren Buffett & David Swensen , manager of Yale’s fund, strongly recommend index ETFs. A good read we suggest: Unconventional Success: “A Fundamental Approach To Personal Investment” by D. Swensen
What do you think? Do you invest in ETF? Let us now if you have questions!!