ETF is an acronym for “exchange-traded funds.” Like stocks, you can trade them on the stock exchanges any time throughout the day. And like mutual funds, they contain a variety of stocks (or bonds, or commodities). And like both stocks and mutual funds, there are ETF pros and cons.
One of the pros is that, unlike individual stocks, an ETF has built-in diversification (usually – we’ll get to that shortly). And unlike mutual funds, the associated fees are limited, and there is no minimum investment amount outside of the share price.
Aside from these basics, there are actually many characteristics that give ETFs both pros and cons in comparison to other investments.
[text_ad]
Your Quick-Start Guide to ETFs
An ETF is best thought of as a basket of other assets, and buying one share of an ETF is buying one piece of that basket.
Depending on the ETF you buy, you’ll end up owning portions of shares in any number of companies. Traditionally, ETFs were designed to follow specific indexes. For example, there is an ETF that tracks the Dow Jones index called the SPDR Dow Jones Industrial Average ETF Trust (DIA). This ETF of 30 companies has $34 billion of assets, with an expense ratio of 0.16%. Other ETFs, like the SPDR S&P 500 ETF (SPY), track the S&P 500, and contain, as you can imagine, a stake in the 500 stocks in the index.
And in case you’re wondering, the mix isn’t even. Most ETFs, including these two, weight the holdings based, most often, on market capitalization. SPY, for example, has 6.95% of its assets in Apple (APPL), 6.53% in Microsoft (MSFT), 6.18% in Nvidia (NVDA), and so on down the line.
Between these ETFs and others focused very specifically on a particular index, you can now invest in an ETF in just about any sector you want. You could choose an ETF that highlights renewable energy sources and products, such as the iShares Global Clean Energy ETF (ICLN). You can opt for an ETF that tracks marijuana and marijuana-adjacent stocks, such as the Amplify Alternative Harvest ETF (MJ).
ETFs aren’t just for stocks, though. The Vanguard Extended Duration ETF (EDV) holds U.S. Treasury securities. There are also highly specific commodity ETFs, such as the iShares Gold Trust (IAU, which “holds only gold,” according to their prospectus.
The ETF Pros and Cons
As you can probably guess, there are some ETF pros and cons here. The biggest benefit of an ETF is diversification. This is especially true with index ETFs, such as the SPY. However, not all ETFs are very diversified. If all your investments are in one industry or sector, you’re not going to be very happy when that sector falters. If you want to “diversify” within an industry, though, an ETF can be a great option.
The downside here is that you won’t get those big gains that come from an individual stock. You’ll get a part of that, of course, but it’s diluted since any particular stock is just a small portion of your ETF. The benefit of that is if one of the stocks in your ETF sinks, it won’t hurt your overall portfolio too much. So diversification is one of the ETF pros and cons, depending on how you look at it.
One other downside is that, like stocks, ETFs can lose value, especially highly concentrated ETFs. You need to do your research just like you would when you invest in any stock.
Perhaps the most significant benefit of an ETF is that it can give you exposure to an industry or index when you don’t feel like any one or two stocks stand out, if you’re bullish on the sector as a whole, for instance.
Many of Cabot’s advisories offer some exposure to ETFs, but if you’re looking to build a full portfolio of ETFs you can find that with Cabot Money Club, where Chief Analyst Nancy Zambell offers portfolios for stock investors, ETF investors, and everyone in between.
[author_ad]