Ah, investing. If budgeting and paying off debt is the dowdy, practical side of personal finance, investing is its stylish, seductive cousin. At once scary (to some) and exhilarating (to others), investing allows us to sit back, relax, and let our hard-earned money grow. In fact, investing is sort of like planting a financial garden that bears the best kind of fruit – money! – with time and maintenance.
But with so many options for investors these days, lots of people wonder which vehicle is best for their financial needs. While mutual funds, individual stocks, and real estate get the most press, a newer and lesser-known investment – the exchange-traded fund (ETF) – is becoming very popular with individual investors, mostly because it combines a lot of the best qualities of stocks and mutual funds.
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So what is an ETF?
I like to think of ETFs as the ultimate stock-mutual fund hybrid – an investment alpha-breed, if you will. ETFs are essentially mutual funds, in the sense that they are made up of a blend of equities. For example, a total stock market ETF would be made up of a range of small to large cap stocks, just as a total stock market mutual fund would be. This is advantageous because it provides a lot more diversity than most investors could achieve by buying individual stocks. But, unlike mutual funds, ETFs are traded on equity markets and bought and sold in shares, just like stocks. So, instead of contributing a set dollar amount (say, $200 per month) to an ETF as you would with a mutual fund, you would purchase additional shares to of the ETF to add to your portfolio.
Probably the most attractive aspect of ETFs, though, is their incredibly low fees, which can significantly impact investment returns. The problem with mutual funds is that they have to be managed by professionals, and that, of course costs money. These costs are passed on to investors in the form of management fees. ETFs, though, are almost all “passively” invested, meaning that there’s no professional on the other end directing your money – it’s pre-set to keep pace with certain markets or indexes. This means that more of the money that you’re putting in actually being invested, as opposed to paying managers.
Now that you’re convinced that ETFs are the best investment vehicle out there, I should mention that, depending on your “style” of growing your portfolio, there may be some drawbacks. The main drawback that a lot of investors see is trading fees associated with the buying and selling of ETFs. While there are a lot of discount brokers out there today, trades still cost between $5 and $12. If you’re planning to invest every month, that adds up over the course of the year. Another potential drawback of ETFs is stability – a lot of ETFs come on the scene every year, and many quickly fold. So when you’re shopping for ETFs, it’s best to look for those that are sold by well-established companies and that have a strong track record of solid performance.
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Treating your money with respect means researching your investments carefully and making choices that line up with your financial goals, no matter which vehicle you choose. But now that you know all about ETFs, you can consider using them to help your financial garden grow!
What The Heck Are ETFs? was originally featured on Quizzle Wire
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