While their popularity has surged over the last decade (to the tune of more than $2 trillion in assets as of the end of 2014 according to the Investment Company Institute) exchange-traded funds, commonly referred to as ETFs, still remain somewhat of a foreign concept to many investors. ETFs are versatile investment vehicles that can be used to create a diversified investment portfolio, or used to target virtually any segment of the market. In fact, ETFs serve as the building blocks for TradeKing Advisors’ asset allocation portfolios. In this blog, we’ll provide a brief primer on ETFs, as well as 3 key benefits ETFs can provide to an investor’s portfolio.
What is an ETF?
In its simplest form, an ETF provides many of the characteristics of a mutual fund, but trades like a stock on an exchange, meaning they can be bought and sold anytime during trading hours. ETFs are pooled investment vehicles allowing investors to invest in baskets of securities from different corners of the market. Most ETFs are passively managed and are designed to mirror an index, versus actively picking securities. So rather than engaging in the daunting, laborious task of trying to manage a portfolio of individual stocks and bonds, and investor could instead invest in a handful of ETFs and instantly gain exposure to thousands of stocks and bonds from around the globe.
ETFs provide the ability to achieve an immense degree of diversification with relatively low investment minimums. Take the largest ETF by assets, the SPDR S&P 500 ETF [SPY], which is designed to track the S&P 500 index. By purchasing just one share of [SPY], an investor gains exposure to 500 of the largest U.S. based companies, helping to reduce the risks associated with single-stock exposure by diversifying across different industries and sectors. The ETF marketplace is now so comprehensive that investors are able to gain broad exposure to all corners of the market including different sectors, countries, and asset classes such as bonds, real-estate investment trust, and commodities. Look under the hood of a TradeKing Advisors portfolio, and you’ll find a globally diversified portfolio that’s invested in more than 6,000 publically-traded companies from over 50 countries around the globe.
Due to the passive management style of most ETFs, they tend to be significantly more cost effective than their actively managed mutual fund counterparts. According to a report by ETF.com, while the average U.S. equity mutual fund charges 1.42%, the average equity ETF cost only 0.53%. Much of this can be traced back to the structural differences between the two investment vehicles. Mutual funds tend to have high overhead cost, including transaction fees, distribution (12B-1) fees, and sales charges which can approach 5% or more. The underlying expense ratio of an ETF is one of many factors considered when evaluating an ETF for inclusion into our portfolios at TradeKing Advisors. In fact, the average weighted ETF expense ratio of our portfolios is only 0.17%.
With more than 1,000 exchange-traded funds available in the marketplace, investors and traders alike can access an ETF to track nearly any market niche. They can also be effectively combined to create a unique mix designed to meet a specific investment objective. ETFs allow TradeKing Advisors to design and manage a low-cost, globally diversified portfolio that’s customized for your goals and risk tolerance. Whether you’re a conservative investor or seeking aggressive growth, ETFs allow our investment team the ability to design a precise asset allocation optimized to provide the highest return potential for your specific comfort level of risk.
In an upcoming blog, we’ll provide an in-depth look into TradeKing Advisors’ methodology for selecting which ETFs to include in our clients’ portfolios.