ETF stand for exchange traded funds, which are investment funds traded on a stock exchange, with an aim of tracking the performance of an index and to provide similar returns to the respective index.
There are various benefits to investing in ETF’s in comparison to your average mutual fund. Blackrock, the largest asset manager outlines 4 key benefits as follows:
1. Diversification benefits: ETFs provides access to a variety of investment options far exceeding that of mutual funds, extending across all asset classes, sectors and geographies. ETFs are designed to track market indexes that may contain hundreds or even thousands of securities. This can offer investors diversification of a typical index mutual fund with the trading flexibility of a stock. Any time during the trading day, an investor can execute a single ETF trade and obtain broad exposure to an entire asset class, country, region, or sector.
2. Cost effectiveness: ETFs often have lower costs than other types of investment funds, due to the fact that investors are not charged with hefty management fees.
3. Transparency to investors: Investors are fully aware of their investments and have fully control of what to add to their portfolio, in contrast to investing a mutual fund, where portfolio holdings are directly determined by portfolio managers.
4. Liquidity: ETFs are traded on stock exchanges. The high level of liquidity suggests that it is easier to liquidate your investment in the case that returns do not match up to your expectations.
In addition to these four obvious benefits, ETFs are also significantly more tax efficient due to the following reasons. First, a large number of ETFs track index funds. Most index funds keep trading to a minimum, which means fewer taxable gains are realized. All of this should make ETFs more tax-efficient than most mutual funds,
However, it should be noted that when it comes to tax efficiency, not all ETFs are provided with the same tax benefits. Some ETFs may experience high trading volume, (such as the emerging market iShares or the Spider). Investors who aim to benefit from such feature should be cautious in their selection process.
In short, ETFs offer a unique range of benefits that are unmatched by any other type of asset, but at the same time, investors should remain cautious in the process as there are significant risks.