ETF = exchange-traded fund. And it tops a lot of people's "fave investments" list.
Explain for people who don't have a list like that.
Because ETFs combine a few attractive characteristics of stocks and mutual funds, many experts say they offer the best of both worlds. Like mutual funds, they group together a lot of a certain kind of asset (think: stocks, bonds, or even gold) and sell it as a bundle. Investors then buy and sell these funds on exchanges – hence the name – where prices vary throughout the day, just like with individual stocks. (Btw, the price of a mutual fund is set just once daily at the end of each trading day.)
But how exactly do ETFs work?
Kind of like a bouquet of flowers. As in, each pick can be lovely on its own. But a pro can mix and match a variety of blooms to create a beautiful arrangement. In an ETF, investments are the blooms, all rolled up into one bunch – um, fund – that's designed with a certain theme in mind. Maybe it's a tech stock ETF and, like a simple blend of different-colored roses, it bundles together shares of different (but similar) tech companies like Apple, Microsoft, and Intel. Or maybe it's an ETF that tracks a specific index like the S&P 500, so it has a much wider range of stocks – like a combo of roses, dahlias, lilies, and bupleurum. You can buy and enjoy it without having to research too much about each company (or learn what bupleurum is).
What makes this strategy so great?
There are a few reasons ETFs tend to be a fan favorite. A big one: instant diversification. That’s your secret weapon against risk. Spreading your money across many types of investments allows the top performers to help keep your portfolio afloat when others aren’t doing so hot.
ETFs are also a relatively low-cost investment option with a median expense ratio of 0.45% for stock ETFs (vs. 1.08% for stock mutual funds), according to the Investment Company Institute. Plus, purchasing a single ETF allows investors to buy into dozens, hundreds, or even thousands of assets at once, which is more cost-effective than buying all those individual stocks. Read: better than BOGO. And once the purchase is made, these funds are typically pretty hands-off. That means they can charge less because they tend to require less time and attention from an investing pro than a mutual fund with more active management.
Oh, and if you’re investing through a taxable account, ETFs could save you money on Tax Day. Let us explain: an actively managed mutual fund requires tons of buying and selling within the fund, since its manager is always trying to beat an index’s performance. More transactions = more realized capital gains (reminder: that’s the *taxable* profit you earn from selling an asset that increased in value). With ETFs, assets move in and out of the fund less often, leading to fewer transactions and taxable gains.
OK, how do I get in on this?
You can buy ETFs through a regular, taxable brokerage account. Or a tax-advantaged investment account, like an individual retirement account (IRA) or 529 plan. If you need a little guidance picking which ETFs to buy, you could sign up with a robo-advisor, which can construct your portfolio out of low-cost ETFs and manage your investments automatically. Some popular ones: Ellevest, Betterment, and Wealthfront. Whatever direction you go, make sure to read the fine print on fees, because they can vary from broker to broker. And ETF to ETF.
All investments carry some level of risk. But a low-cost, passively-managed ETF can be a safe(r) way for you to bloom as an investor.
Subscribe to Skimm Money
Your source for the biggest financial headlines and trends, and how they affect your wallet.