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Benefits of ETFs in an Investment Portfolio

December 17, 2020 · 5 minute read

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Benefits of ETFs in an Investment Portfolio

Are you thinking about investing your money, but don’t even know where to start? You’re not alone.

Investing can seem confusing and, let’s be honest, a bit overwhelming. Maybe you think it’s best to save now and invest later. When later comes you will be older, and therefore wiser.

But, once you pay off high-interest credit cards and loans, it may make sense to get started investing sooner rather than later. When you start investing your money towards long-term financial goals, it can start accruing returns and adding up faster than just savings alone.

And it doesn’t have to be confusing. ETFs are a popular way to build a simple and low-cost diverse portfolio. There are many investing benefits to ETFs, which is why they’ve grown in popularity both for D.I.Y. investors and for more traditional money managers.

If you’re looking to invest a lump of money for a long-term investment goal, with no minimums, then ETFs could be a good investment strategy.

Let’s understand how these funds work, how ETFs are traded, and what the advantages of ETFs are.

What Are ETFs?

ETF stands for exchange-traded fund — but what does that mean?

An ETF is a basket or a fund made up of many different investments or securities rolled into a single entity. This allows an investor to easily access a broad range of different markets and investments.

That means things like stocks and bonds or even funds of stocks and bonds are pooled together into an ETF—and shares of the ETF are then offered to investors on the major exchanges. So buying one share gives you proportional access to all the things in that fund.

Typically, an ETF tracks a benchmark — meaning the fund aims to invest to match the returns of certain benchmarks. Market ETFs, for example, track a major index, like the S&P 500. (There are also actively managed ETFs, but most ETFs are passively managed.)

This might sound very similar to a mutual fund, because they are pretty similar. In many ways, the mutual fund was the predecessor of the ETF. But there are some key differences. Mutual funds are traded only once per day, after the market closes, because of how they’re structured and regulated.

ETFs, however, are traded on the exchange —hence the name “exchange traded fund.” That means you can buy and sell ETFs any time of day. That flexibility is one of the benefits of ETF investing. .

ETFs are traded by buying and selling them on the exchange, much like stocks. However, one of the advantages of ETFs is that they can be used to build long-term portfolios instead of trading every day. Still, the benefits of being able to buy and sell ETFs with flexibility allow investors to build diverse portfolios to reflect their needs.

What Are the Benefits of ETFs?

ETFs have become more and more popular in recent years, especially with the rise of online brokerages allowing people to easily buy and sell them.

As an investment tool, ETFs have become so popular that there were $3.4 trillion in assets in ETFs at the end of 2017. That’s because there are certain benefits for investors.

Here are some of the advantages of ETFs:

•   Quick Portfolio Diversification: The biggest benefit of an ETF is you don’t need a lot of money to invest in lots of different things. One share of an ETF gets you access to many different companies.

•   Accessible Across Markets: There are also a range of ETFs on the market now: stocks, bonds, commodities, real estate, and hybrids that offer a mix. ETFs also vary in how they target certain assets — aggressively or not, specific to one asset class or broad. So investors should be able to find what they want and build a diverse portfolio.

•   Less Overhead: Because most ETFs track against an index benchmark , they aren’t actively managed by financial managers trying to beat the market. That makes them a more cost-effective bet and it means there’s less overhead and fees.

•   Lower fees: ETFs are typically low-cost, with many charging less than 0.25% per year, although some brokerage firms may charge transaction fees for trades.

•   Easy to Trade: As mentioned, the ability to trade ETFs throughout the day adds to their flexibility. Prices are determined by the market and change throughout the day.

You do have to pay a brokerage commission to buy or sell an ETF, although many online brokerage firms, including SoFi Active Investing, do not charge a commission. There can be more hidden costs to ETFs too, such as the expense ratio and a bid/ask spread, which can add up.

For example, Schwab compared two investors using the same hypothetical ETF — which one investor traded just twice in the year and the other traded heavily — and found a drastic difference between the fees they would pay ($65 v. $1,065 on a $10,000 investment).

However, some ETF providers allow affiliated brokerage customers to buy and sell without paying a commission. Additionally, the rise of online discount brokers has made it cheaper and easier to invest in ETFs.

The Advantages of ETFs in Your Investment Portfolio

If you want to start investing, then ETFs could be an option — depending on how actively you want to trade and what your financial goals are.

Instead of trying to build a basket of investments where you have to buy into each stock or asset, you might be able to buy into an ETF that covers a wide range of assets with just one transaction. It can give you more diversification for fewer fees.

If you’re planning to build an investment portfolio on your own, then ETFs have the potential to make it simpler. ETF advantages include having to buy one share of a fund to get exposure to a wide range of assets. First, determine what sort of portfolio asset allocation will help you meet your financial goals — that’s the make-up and mix of different asset classes.

Then, you may be able to select ETFs to match your desired investment make-up. It can be important to rebalance throughout the year to keep your portfolio at its desired make-up.

There are certainly ways to get more complicated with ETFs — there are derivatives of ETFs available, like shorts and option contracts — but you don’t have to get into those if you don’t want to.

The Disadvantages of ETFs in Your Investment Portfolio

When comparing the costs of investing in a particular stock with investing in ETFs, the costs may be higher for the ETFs if there are management fees charged.

Plus, one of the potential disadvantages of ETFs may be that in some niche situations, there may be less diversification in ETF investing than what someone might desire; this can be true with foreign stocks, for example—or, in some sectors, there may only be a narrow group of equities available, limiting choice.

In addition, although there are ETFs that pay dividends, they may not have as high of a yield when compared to individual stocks or stock groups with high yields. Granted, the risks are often lower when investing in ETFs—but this can translate into less reward.

This is true, at least in part, because investors can specifically select stocks because they offer the highest dividend yields; but, when putting money into ETFs, investors are choosing a bundle of investments from a broader swath of the market, which will often average out to a lower yield.

Here’s one more factor to consider about ETFs. Diversification is a commonly mentioned benefit of them, but this doesn’t mean that this type of investment won’t experience volatility, because every investment can.

How much can depend upon market conditions as well as upon the ETF’s overall focus. One that is broader will, in general, have fewer swings than those that focus on a narrow sector.

ETFs are becoming increasingly more popular, with some of them being more targeted in focus than others.

So, being aware of what investments an ETF contains can be important for an investor who chooses to put dollars into this financial vehicle.

When starting out, it can sometimes help to get professional guidance to begin your investing or to pick and choose ETFs.

SoFi Invest uses ETFs, including proprietary ETFs, to build diverse portfolios based on your risk tolerance and goals.

The mix of ETFs SoFi uses follow 20 different indexes that track groups of investments or asset classes, like high-yield bonds, real estate, or international stocks.

You can start an invest account with just $1. Get started with the SoFi App today.

External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
Third Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third party trademarks referenced herein are property of their respective owners.
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