Affordability: Most ETFs have low minimum investment requirements, often less than $1,000. ETFs can be used to invest small amounts of money into many individual stocks or bonds. Portfolio diversification: Investors can use ETFs to diversify their portfolio with various assets (e.g., stocks, bonds, real estate, and commodities), even with small portfolios. Transparency: Most ETFs disclose their holdings daily.Professional management: Portfolio managers select individual investments based on the objective of the ETF.
There may be tax implications, too. Investors are taxed on ETF capital gains and dividend distributions. Investors can be taxed on capital gains when the ETF sells underlying investments, but ETFs are structured so that they generally avoid this problem. ETF investors also pay tax on capital gains when the shares are sold, and some ETFs (such as some precious metal ETFs) can have higher capital gains rates. Investment plans usually begin with deciding how much money will go into the different types of assets (such as stocks, bonds, and commodities), also called “asset allocation.” Multi-asset ETFs combine different types of assets to create outcomes for conservative, moderate, and aggressive investors. A multi-asset ETF may be a good choice for a novice investor, because the portfolio manager decides different asset class allocations and the individual investments. The investor only needs to determine what type of portfolio they want. For example, an aggressive multi-asset ETF might have only 17% invested in bonds, and more than 80% invested in stocks. A conservative multi-asset ETF could be 66% bonds, with the rest allocated to stocks, cash, and money markets. Overall, an ETF’s risk is based on the strategy and underlying investments. However, ETFs trade on exchanges, and the shares’ market price can be lower or higher than their net asset value (NAV). It’s possible (although unlikely) for an ETF’s share price to decrease even though the value of the underlying investments has increased. Opening an online account typically doesn’t require a minimum investment. After opening an account, you can access a broad menu of investment products, investor research, and education resources online or on an app. ETFs come as two basic types. Passive ETFs hold underlying investments to match a financial index, like the S&P 500. For example, the SPDR S&P 500 ETF Trust (SPY) tracks the S&P 500. Active ETF portfolio managers select investments in an attempt to outperform a benchmark, like the S&P 500, rather than match it like a passive ETF. Generally, active funds are more expensive than passive funds. Types of ETFs within these two buckets include:
Sector ETFs: These offer exposure to specific economic sectors like technology or utilities. Foreign market ETFs: These target investments in economic blocks like the European Union, regions like Asia, or specific countries. Investment style and preference: ETFs can invest according to styles and preferences, such as funds that invest in large-cap stocks, or stocks that pay high dividends. Asset class: Some ETFs only hold one type of asset, such as high-risk bonds. Other ETFs specialize in unusual asset classes, like commercial real estate or a specific currency.
Compare the fund’s ratings, expenses, and historical performance using your broker-dealer’s online tools. If you’re just beginning, look for ETFs highly rated by one of the agencies, such as Morningstar or Factset. ETF providers include iShares, Vanguard, and State Street Global Advisors. Some ETFs are only appropriate for experienced, sophisticated investors who understand the risks. For example, leveraged ETFs magnify both gains and losses, as they deliver the multiple of an index return, daily. For example, a 2x S&P 500 ETF is designed to double the S&P 500 return on a daily basis. Inverse ETFs track a specific index, but investors profit when the index is down. Inverse ETFs can also be leveraged. You can purchase shares of an ETF online or through your broker-dealer’s app. You may also be able to call the customer service number for guidance through the process.
