I’m going to let you in on a little secret: there’s a cheaper, easier way to get some skin in the stock market game. You just need to remember the letters ETF, otherwise known as an Exchange Traded Fund. So, what is an ETF anyway?
Here’s how it works: essentially, an ETF is an investment fund. You buy into a part of this investment fund. Then it is bought and sold on a stock exchange just like a stock.
What makes an ETF stand out is what it includes. As a fund, an ETF owns assets like stocks or bonds. When you buy into an ETF, you also own its underlying assets. Think of it this way: when you receive a fruit basket, you get all the fruit in it (and maybe some cheese, too). In this case, the ETF is your basket and the underlying assets are everything in it.
ETFs allow you a range of control in several key areas of investing:
- ETFs are low cost. When you purchase an ETF, you pay a commission on the transaction (typically under $10) and the underlying expense ratio, which is the fee the institution charges to administer the fund. Having a low expense ratio is one thing you can control and it helps to improve long-term investment performance.
Read More: Investment Fees Matter!
- ETFs are tax efficient. Because ETFs are traded on an exchange, there are fewer taxable events affecting your underlying assets. Read a terrific explanation of how this works from Barron’s.
- ETFs are efficient and easy. With just a click, you can purchase a slice of an entire pie. Want to buy gold? Buy an ETF that owns gold. What to buy U.S. Treasuries? Buy a Treasury ETF. It’s that simple.
- ETFs help you build a well-diversified portfolio. When your portfolio holds a variety of assets, you can more easily control the level of risk in your investments. That’s a critical piece of having a long-term investment plan.
Read: Creating a Long-Term Investment Plan: Tune Out the Noise!
Let’s say you want to “own” the S&P 500 index. To do that, you would have to buy shares of stock in 500 separate companies—a costly and time-consuming endeavor! Especially for someone who isn’t managing hundreds of millions of dollars.
Instead, buy an ETF that does the work for you. You’ll have almost the exact performance as the index without spending tons of time or money on it (ETFs don’t perfectly match their index. Learn more about tracking differences). And you can buy and sell with the same flexibility.
ETFs are a cheap, easy, and low-risk way to invest in a stock exchange. While mutual funds or individual assets have their benefits, ETFs are the hidden gems that can help you build a strong, diverse investment plan on your terms. For a more in-depth discussion, check out Howard Marks’ recent memo on the topic.
Now that the secret’s out, contact me to learn more about how using ETFs may make sense within your financial plan.
Jim is a financial advisor and owner of Thinking Big Financial, Inc. Thinking Big Financial is a fee-only registered investment advisor offering financial planning and investment management services. Specializing in working with the LGBTQ Community.
Please read my legal disclaimer here.