One investment option that investors may be lacking information about is ETFs, or exchange-traded funds.1 ETFs are investment products that typically own a portfolio of stocks, bonds and/or other securities. Investors buy these ETFs on stock exchanges through brokerage accounts, similar to the way they buy stocks.
The advantages that ETFs can provide investors and their portfolio included enhanced diversification and risk management, lower costs, and potential tax benefits.
Here are three questions investors can consider as they talk with their financial advisor about ETFs:
What market exposure will I be getting by owning an ETF?
With over 2,200 ETFs available for purchase in the US, it’s important to know what specific element of the market you will be adding to your portfolio. Some ETFs target a specific industry or sector of the market, such as technology, brokerage, etc. Others target a country or region of the world, while some target a specific method of investing. It’s crucial to know what it is that you’ll be accessing with the ETF.
What costs are associated with ETF strategies?
The first cost to be aware of is simply the commission charged by your broker to purchase the ETF. Another cost you should be aware of is the cost of the ETF itself, also known as the expense ratio. All ETFs charge fees and investors should be aware of the total fees charged to cover the cost of picking the securities and the operational costs of servicing the strategy. It makes sense to research whether or not the total expense ratio charged is competitive relative to comparable ETF strategies.
Lastly, there is a cost called the “spread.”2 Typically, the spread is a few cents of additional cost that are added to the price of ETF trades on the exchange. This is used to cover the costs to create new shares of the ETF. It is also used to compensate market makers3 for the risk they take creating an efficiently traded market for the ETF. The lower the spread, the lower the cost of the ETF purchase for the investor.
How might an ETF fit within my overall portfolio?
Careful consideration has to be paid to how each ETF fits within a portfolio. Like all investments, ETFs involve risk. Investors can talk with their financial advisor or an investment professional about the variety of outcomes an ETF can aim for, including return-seeking, risk reducing, diversification enhancement, etc. All of this is useful to understanding how each ETF may contribute to the broader portfolio-level goals.
Inflows in to US-listed ETFs are on pace to top $200 billion as of mid-year 2019. We believe that activity in this space is likely to continue. As you consider if an ETF strategy might help you achieve your financial goals, working with a financial advisor can increase your understanding of the available options, opportunities, and risks.
2 A spread is the difference between the bid and the ask price of a security or asset.
3 The term market maker refers to a dealer in securities or other assets who undertakes to buy or sell at specified prices at all times.
Investing involves risk, including the risk of loss. Investment risk exists with equity, fixed-income, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided.
Diversification does not guarantee a profit or protect against a loss.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.