Are ETFs a good investment?

The purchase of a single ETF can act as an entire portfolio, which in generations past might have taken years to build through the purchase of individual shares of stock. Novice investors are often overwhelmed by their choices, and ETFs can remove a lot of guesswork and anxiety. For beginners who want to get their money in the market while they research, study and learn more, it's hard to imagine there's a better place to park their cash than in an index ETF .

Is an ETF Better Than a Stock?

Whether or not an ETF is better than a stock depends on your own personal investment objectives and risk tolerance. Individual stocks can be more volatile than ETFs, but they may also offer the chance of outperformance. Exchange-traded funds that replicate the performance of an index by definition provide an average return. If you're trying to beat the market return, for example, you can potentially do it with a stock, but it's not possible with an index-tracking ETF

What Are the Disadvantages of an ETF?

ETFs can have many disadvantages for those who don't understand them. For example, although ETFs typically hold tens to hundreds of securities, this doesn't necessarily mean that they are diversified. For example, some of the semiconductor ETFs may hold 30 or fewer securities, all in a single industry. This makes them not diversified portfolios that may be subject to volatile swings. Another thing to consider is that as most ETFs track indexes, they're not good vehicles for outperformance. While it's difficult for even professional investors to outperform the S&P 500 year after year, at least owning individual stocks gives you that potential. But owning an S&P 500 ETF, for example, you're guaranteeing yourself an average return, with no chance to beat the market

Are ETFs Good for Beginners?

ETFs can be among the best options for beginning investors because they are simple to use and understand and they are among the most inexpensive investment options there are. No less than billionaire Warren Buffett agrees, saying "In my view, for most people, the best thing to do is own the S&P 500 index fund."

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What Is an ETF (Exchange-Traded Fund)?

June 21, 2024

7 min Read

Written by John Csiszar

Edited by Emily Gadd

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An ETF is a collection of securities packaged and sold in a single basket, or fund. Most ETFs are passively managed and designed to mirror the performance of indices, such as the S&P 500. The funds may include multiple different sectors like manufacturing, tech, clean energy, or even strategies like dividend investing.

ETFs are easy to buy and sell and they can be affordable. They can expose you to a variety of securities that allow you to diversify with the purchase of a single share.

Since they don’t involve picking stocks, you can build a complete portfolio with just one ETF, making it a beginner-friendly investment strategy.

ETFs and Passive Investing

Unlike actively managed portfolios, ETFs don’t have managers that frequently buy and sell stocks or other securities in an attempt to maximize performance. Instead, your portfolio is monitored and the manager will only buy and sell stocks if the fund isn’t on track with the index it’s mirroring.

An S&P 500 index manager, for example, won’t pick and choose individual stocks in an effort to beat the market. Rather, they will simply buy or sell stocks for the portfolio when the index itself adds or removes companies from the index.

ETFs can include stocks, bonds or a blend of investment types, and they can be made up of just a few securities or many. Although most ETFs focus on stocks or bonds, they can also include other assets, like commodities (i.e., gold) and real estate. They can’t include anything the SEC doesn’t regulate. Until recently, there were no cryptocurrency ETFs. Although the SEC now allows some crypto ETFs, there are some limitations, like fine art ETFs.

How Are ETFs Different From Mutual Funds?

ETFs are similar in many ways to mutual funds, but there are some important differences. The most important one is that the ETFs trade on an exchange and can be bought and sold at any time that the stock market is open. Traditional mutual funds, on the other hand, must be bought directly from a mutual fund company – although they are accessible through a number of different brokers – and they are only priced once per day, after the market closes. Either way, you’ll need a brokerage account to buy or sell shares.

Although there are exceptions, traditional mutual funds are actively managed, whereas ETFs are passively managed.

Advantages of ETFs

Immediate exposure to many securities in one purchase.
ETFs offer diversified investing, which can make your investments less risky
Low costs compared to traditional mutual funds.
Ease and accessibility — you buy and sell shares in real time, just like stocks.
Tax advantages over standard mutual funds and other common investments.

Disadvantages of ETFs

ETFs tend to have lower dividend yields, although some track dividend stocks specifically.
In some cases, as with some foreign stocks, ETFs are limited only to large-cap stocks, which makes it harder to diversify with small- and mid-caps.
Even ETFs with dirt-cheap expense ratios charge at least a nominal fee. Individual stocks, on the other hand, do not.

Types of ETFs

The following are the most common types of ETFs, but each category is broad and can include many subcategories.

Index ETFs: Track a specific index of the market, like the S&P 500
Fixed income ETFs: Invest solely in bonds and other fixed income products like preferred stocks
Commodity ETFs: Invest in commodities, like gold
International ETFs: Invest in foreign markets
Currency ETFs: Track specific currencies
Inverse ETFs: Performs opposite the index it tracks — increasing in value when the index decreases and vice versa
Leveraged ETFs: Rebalanced daily to reach a leverage goal
Actively managed ETFs: A fund manager makes decisions on the fund’s portfolio
Exchange-traded notes: debt securities issued by financial institutions
Bitcoin ETFs: Recently approved by regulators, these ETFs invest in the cryptocurrency Bitcoin
ESG ETFs: Invest in stocks that score highly on environmental, social and governance metrics
Passively Managed ETFs: Most ETFs are passively managed, meaning they simply track an underlying index
Industry/Sector ETFs: Track stocks in a particularly industry or sector only, making them not diversified
Dividend ETFs: Invest in stocks that pay higher-than-average dividends
Stock ETFs: Some ETFs can be actively managed, buying and selling stocks according to the fund’s investment objectives
Thematic ETFs: Follow certain investment themes or indexes, such as “the future of finance” or “transition to a low-carbon economy”

Good To Know

When people talk about the “stock market” as up or down, they’re usually referring to the S&P 500 index, which tracks the 500 largest U.S.-based corporations. Several funds, like Vanguard 500 Index Fund ETF (VOO), track the S&P. That means you can invest in the top 500 companies with the purchase of a single share of a single fund — which happens to be among the cheapest ETFs on the market.

Examples of Popular ETFs

If you’re new to the game, these are some of the best-known ETFs on the market. They might be a good place to start.

SPDR S&P 500 (SPY): The first and most famous of all the S&P 500 funds.

Assets under management: $533.35 billion
YTD return: 15.76%
5-year return: 15.71%
Expense ratio: 0.09%
Dividend yield: 1.28%

SPDR Dow Jones Industrial Average (DIA): This one tracks the Dow, an index that’s almost as important and widely followed as the S&P 500.

Assets under management: $32.93 billion
YTD return: 3.79%
5-year return: 11.45%
Expense ratio: 0.16%
Dividend yield: 1.74%

iShares Core S&P 500 ETF (IVV): The second-largest S&P 500 ETF tracker.

Assets under management: $462.04 billion
YTD return: 15.51%
5-year return: 15.74%
Expense ratio: 0.03%
Dividend yield: 1.31%

Vanguard S&P 500 ETF (VOO): An S&P 500 ETF tracker from the very popular management firm Vanguard; also, the 3rd-largest ETF in the world.

Assets under management: $1.14 trillion
YTD return: 15.82%
5-year return: 15.76%
Expense ratio: 0.03%
Dividend yield: 1.32%

Vanguard Total Stock Market ETF (VTI): This ETF from revered Vanguard tracks every security in the entire stock market in a single investment.

Assets under management: $1.6 trillion
YTD return: 13.97%
5-year return: 14.90%
Expense ratio: 0.02%
Dividend yield: 1.36%

Invesco QQQ Trust Series I (QQQ): Often referred to as “the Q’s,” this popular ETF tracks the Nasdaq-100 index, which holds many of the biggest tech names.

Assets under management: $270.07 billion
YTD return: 18.64%
5-year return: 21.84%
Expense ratio: 0.20%
Dividend yield: 0.58%

How To Buy and Sell ETFs

Buying or selling an ETF is just like buying or selling a stock, as they both trade on the public exchanges. But first you’ll need to have a brokerage account. If you don’t yet have one open, you’ll need to provide personal and financial information, such as the following:

Name
Address
Date of birth
Social Security number
Bank information to fund your account

As each financial institution is different, you may be asked for additional information to open your account.

Once you have an account, you can buy or sell any ETF you like. Simply select the ETF(s) you want to purchase and either inform your broker or enter the trade yourself online. If you plan on trading ETFs frequently or are investing small dollar amounts, it’s imperative that you choose a zero-commission broker. Fortunately, most firms have now adopted this zero-commission structure for both stock and ETF trades.

Even though ETFs generally comprise multiple securities, you should analyze each fund with the same level of scrutiny as you would for individual stocks. As most ETFs track indexes, it’s relatively easy to find out what individual securities are in each fund. Use this information to ensure that the ETFs you buy match your investment objectives and your risk tolerance.

Tax Implications of ETFs

Owning an ETF doesn’t protect you from all tax obligations, but it can reduce them due to their structure. All mutual funds, whether traditional or in ETF form, are required by law to distribute all their income and capital gains to shareholders. But as most ETFs are index trackers, there aren’t as many buy or sell transactions as with an actively managed fund, so any taxable distributions are generally limited. Of course, if you frequently buy or sell an ETF on the exchange, you’ll be liable for the appropriate short- or long-term capital gains taxes, just as with a stock or mutual fund.

Andrew Lisa and Sean Dennison contributed to the reporting for this article.

Data is accurate as of June 20, 2024, and is subject to change. ETF information was sourced from Yahoo Finance.

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