Why are ETFs so popular?
What is an ETF
An Exchange Traded Fund (ETF) is a simple and inexpensive investment solution. These funds shares are traded on the stock exchange just like regular stocks. They contain different types of investments such as stocks, bonds, commodities and other financial securities.
An ETF can copy the evolution of a stock market index (S&P500, S&P/TSX60, CAC40…), a particular sector (agriculture, technology…), the market of a specific country or any other theme you could think of. Thus, by purchasing a an ETF share replicating the S&P 500, “Mr. Everyone” could therefore invest his money in a fund representative of 500 of largest companies on the American stock market, without having to own each of those S&P 500 stocks.
It is easy to notice from the following chart that ETFs have become more and more popular over the years. In fact, there are already more than 7,000 ETFs in the world and the amount of money invested in this solution has more than sextupled over the past ten years. It is possible to ask how and why this type of investment is creating such enthusiasm among investors.
Advantages of ETFs
ETFs succeeded in attracting investors thanks to certain assets, which allow them to differentiate themselves from other means of investment:
- Access to a Diversified Portfolio: As stated earlier, for most individual investors purchasing shares of an ETF is the ideal type of investment for building a relatively diversified portfolio through a single investment.
- Low management fees and brokerage: The management fees of a passively managed ETF are at most 1% and normally around 0.2%. While its “cousin”, the mutual fund (with a similar solution, but actively managed by analysts ), has management fees ofaveraging2%. Which can be a significant part of long-term investment.
- Liquidity and transparency: ETFs are traded onthe market like any other stock. Thus, the price is constantly updated and any exchange is allowed during the day. Whereas for a mutual fund, the value and the exchanges are only updated once per day. In addition, a shareholder with shares in an ETF has daily access to the updated composition of the portfolio, compared to each quarter in a mutual fund. The investor therefore has access to the fund’s activities and full transparency.
Limits of ETFs
While ETFs have many advantages, keep in mind that this is not a magical, risk-free investment. It’s common for new investors to make poor decisions, so this section is meant to remind you of some behaviors to avoid when investing in an ETF.
First, you should not “judge a book by its cover”, there are many, many ETFs on the market and although two of them might claim to belong to the same theme, they are likely not perform the same because they do not necessarily own the shares of the same companies. It is common to see companies in the same sector perform really differently, no matter how much enthusiasm is created in the sector. Thus, it is wise for any investor to do his research and comparisons beforehand. There are many sites where you can compare and study the potential of ETFs.
Second, although there are a many new ETFs that are performing exceptionally well in the market, not every investor should jump on the new trend everyone is talking about. Some professionals like to say that the more an ETF gets in the news, the less money it makes to invest.
Third, novice investors may think that any ETF provides access to a diversified portfolio. However, this is not always the case especially in themed ETFs, sometimes it is a risky and high volatility portfolio that is more prone to big losses than gains! So it is once again wise and even mandatory for any sane investor to do his research by studying the financial reports of the major firms, the expense ratios of the ETF, etc.
Currently in the news, the US elections are an event that historically has had a significant impact on the country’s economy, the stock market and therefore indirectly on exchange traded funds. It would be interesting to study how the elections this year have influenced the international stock market.
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