ETFs act like indexes and can follow certain market sectors. However, unlike an index, you can purchase an ETF with one easy, single transaction. Basically, you are purchasing a mini portfolio, not a basket of stocks, as you do with an index. That makes life easier when targeting a certain price. You also get filled on your complete order as opposed to a basket where you are chasing each individual stock, which is a lot more difficult.
Since there is only one transaction per trade, commissions are usually lower on an ETF as opposed to that of an index, which requires a basket of stocks and multiple trades. Also, there are no load fees, and managing fees tend to be lower for ETFs as opposed to regular mutual funds, as well.
If you want to learn more about keeping investing costs down with ETFs, you can learn about 5 ways to save money with ETFs.
Capital gains taxes are generally lower for ETFs than for traditional mutual funds due to the structure of each trade. When a gain is realized in a daily mutual fund trade or even within an index trade, capital gain taxes are incurred immediately. In the case of exchange traded funds, the individual capital gains are not realized until the assets are sold with the entire fund. Therefore ETFs are a "tax friendly" investment.
Also, in the case of dividend ETFs, the actual dividend payouts are treated differently and can create a tax advantage here as well. Learn more about paying taxes on ETF dividends.
Many ETFs list options, swaps, and futures contracts, which are great tools for risk-managing your portfolio. So whether you want to hedge your ETFs with calls and puts or trade ETF volatility with option straddles, some funds will have that flexibility.
Also be aware that sometimes options and futures are in ETFs, such as leveraged funds. So if that is the case, be sure to learn about the impact they can have on your trading strategy and the risks involved.
Speaking of flexibility, like an equity, ETFs trade throughout market hours. ETFs can be sold short or on margin, and prices are continuously updated during the trading day. In other words ETFs trade just like equities on the stock market.
The company sponsor, designer, and creator of the ETF publishes the list of assets in the fund on a daily basis. Most mutual funds publish the constituents on an infrequent basis and are not known for their transparency. However, this is the opposite case with ETFs.
ETFs are meant to follow a particular index or benchmark, but not expected to outperform it (although that can happen on occasion). Therefore, only minor adjustments are needed for the ETF, as opposed to an aggressively managed fund, which is specifically looking for a higher return than its underlying asset. This, in turn, lowers risk and management fees for ETFs as well.
With most ETFs, (open-ended) dividends are immediately reinvested back into the fund. In the case of traditional funds, the time frames may vary. However, while ETFs are tax friendly, one must not ignore the taxes on ETF dividends either.
ETFs are simple in structure and should be easy to understand, with exception of intricate funds such as leveraged and inverse ETFs. So, If you are looking to invest in a certain industry or want to emulate the ROI on a particular index or underlying asset, you are only a trade away from getting started with ETFs.
There are many advantages to including ETFs in your investment portfolio. While mutual funds, equities, derivatives, and indexes are all solid investments, ETFs are a weapon that should be part of your investing arsenal.
Nine Reasons ETFs Can Benefit Your Portfolio
The Many Advantages of ETFs
If you are looking to diversify your investments, hedge against your risk, or gain exposure to a certain industry or market, then ETFs can be the perfect asset for your portfolio. Investors who take advantage of ETFs (and ETNs) and include them as part of their investing strategy reap many of these benefits. Here are some great reasons why.