Why ETFs Are A Good Choice For A Properly Diversified Portfolio

It’s well established that asset allocation is an approach to qualified accounts. By investing in different asset classes, allocated proportionally to meet your financial goals, time horizon and risk tolerance, you can improve the likelihood of achieving the best outcome.

Most of the time, that outcome is a successful retirement, one in which you don’t have to scrimp and save and worry about your financial wellbeing. 

But to achieve that wellbeing, you need a practical strategy for investing your assets. 

Exchange-traded funds (ETFs) represent a popular way to accomplish your investing goals.  

ETFs were introduced in 1993, with the rollout of the SPDR S&P 500 ETF (ASX: SPY). Today, it’s the largest ETF, with $363.955 billion under management. From a modest beginning in 1993, the industry grew to include more than 7,600 ETFs at the end of 2020. 

If you are looking to diversify your portfolio, mitigate your risk or get access to a particular region, sector or market cap, ETFs can be an excellent solution. 

You can now find ETFs tracking all major asset classes, as well as currencies and commodities. Furthermore, there are ETFs that short particular asset classes. 

Here are some reasons why ETFs may make sense for you:

• Broad asset-class exposure: The most well known form of ETF tracks a broad index, such as the S&P 500 index of large-cap stocks. That’s an easy way to begin diversification, as opposed to buying a number of individual stocks and trying to pick the right ones. Essentially, an ETF constitutes its own portfolio. Combine that with others, and you’re making the allocation process easy as pie.

• Ease of trading: Unlike mutual funds, which are only priced once per day, ETFs can be traded at the current price any time the market is open. Like stocks, an ETF with more shares available in the float will be more liquid, meaning you can more easily get the price you want when buying or selling. You can also short an ETF or buy it on margin, as you can with stocks. 

• Cost Benefits: Many ETFs, particularly those that track an index, have low expense ratios, so you can save money over many mutual funds, which may also charge a load fee. In addition to lower operating expenses, compared to an open-end mutual fund, ETFs also have the advantage of lower expenses when it comes to monthly statements and reports, which ETF managers are only responsible for sending to owners of creation units, not to owners who hold shares on an ongoing basis. 

• Tax Benefits: When compared to mutual funds, ETFs enjoy a much more investor-friendly tax treatment. In general, mutual funds trade more actively. Yes, there are actively managed ETFs with more frequent trading, but if you’re invested in an index ETF, it’s very likely the managers will trade less often, which means fewer capital gains taxes for fund holders. The capital gains are realized when you sell your ETF shares.

• Transparency: Regulators require that actively traded ETFs release their current assets every day. A great current example of this is Cathie Wood’s ARK Funds, which send out a nightly email of fund holdings. Mutual funds are only required to publish their holdings once per quarter, and have 60 days after the end of the quarter to do so. 

• Quarterly Dividends:  ETFs pay out dividends in the same manner as a stock. Fund investors receive a dividend payment in their brokerage account every quarter. That is superior to some mutual funds, which only distribute a dividend yearly.

Traditionally, investors hoping to diversify their portfolios had the options of mutual funds or single stocks. That’s changed dramatically. Rather than pricey and opaque mutual funds, investors can easily gain access to all asset classes through ETFs. 

ETFs also offer far better diversification than single stocks. For example, it’s very difficult to properly diversify internationally with individual stocks traded on foreign exchanges, but it’s quite simple to gain access to those securities with an ETF.