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Whether you’re starting to invest or nearing retirement, there are several ways to use exchange-traded funds, or ETFs, to achieve your financial goals, experts say.
An ETF is like a basket of individual assets, such as stocks or bonds, whose shares trade on a stock exchange throughout the day. Generally, ETFs are less expensive than mutual funds, with average fees of 0.17%, compared to 0.44% for mutual funds, according to Morningstar Direct.
“It’s a quick way to get instant exposure to the market at a very low cost,” said certified financial planner Ben Smith, founder of Cove Financial Planning in Milwaukee, noting that ETFs can be bought or sold like actions.
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Here’s how to profit from ETFs with three popular investment strategies.
1. Dollar Cost Schedule
If you’re concerned about stock market volatility, some experts suggest cost averaging, which involves investing a fixed amount of money at regular intervals regardless of market activity. One example is to automatically contribute to your 401(k) every pay period.
“ETFs make it really easy,” said CFP Michael Nemick, co-founder of Thrive Retirement Specialists in Dearborn, Michigan. “This has reduced the complexity previously involved in managing a large investment portfolio.”
Some ETFs represent hundreds or thousands of stocks “in a nice package”, making it easy to estimate the average cost each month with two or three trades, instead of hundreds or thousands, to get a diversified portfolio, did he declare.
2. Asset allocation
ETFs can also be bought or sold quickly to achieve your target asset allocation or mix of investments, which can be compared to the constituents of your portfolio.
Smith said ETFs are an “effective and inexpensive” way to incorporate different asset classes – such as stocks and bonds – into your allocation, depending on your financial goals. These may be adjusted periodically, called rebalancing, based on changes in the stock market and your initial asset allocation.
For some new clients, adjustments could involve simplifying “a mix” of individual stocks and mutual funds into a single broad-market ETF, Nemick said. “When things are simple and transparent, it’s much easier to move forward.”
3. Buy and hold
For long-term investors, advisors generally recommend a “buy and hold” strategy, regardless of market fluctuations. “You really don’t want to touch that investment portfolio,” Smith said, emphasizing “you have to keep your blinders on” when the market is down.
Experts say tax efficiency makes ETFs well-suited for buying and holding. ETFs are generally more tax efficient than mutual funds because financial institutions can exchange the underlying assets for others, known as an “in-kind” transaction, which does not generate capital gains for investors.
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