Investing Basics: Why Use ETF Funds

Posted on January 31, 2014 at 6:19 AM PDT by

The ETF industry has exploded in recent years, that’s for sure. In the early 1990s there were only a small handful and almost nobody used them. By one recent count, there are now 1,194 exchange-traded funds controlling $1.3 trillion in assets.

Investors have come to rely on them to achieve a number of goals, both short- and long-term, and the major retirement firms have begun to market them as the solution to nearly any saver’s needs.

A silver bullet? Perhaps not, but they do have specific features that help serious savers get the job done.

1. Low cost

There are exceptions, as you would imagine in any group numbering over 1,000, but most ETFs are built to offer exposure to a given part of the market at a very low cost. While active mutual funds charge upwards of 1.5%, ETFs provide access to hundreds, even thousands of stocks for as low as 0.05%.

The difference here is not just a number. The fees investors pay managers account for a third and up to half of their potential gain over the years, money that they simply lose to the manager, forever.

etf funds

2. Simplicity

You really could not replicate owning the S&P 500 as an individual investor. The trouble of purchasing and holding (then buying and selling over and over to keep in balance) would be cumbersome, the trading commissions immense. ETFs wrap all that up in a neat package that trades under a simple ticker.

3. Control

Stock pickers sometimes get in an out of single shares in an attempt to avoid losses or take gains while they can. They assume, too often, that a buyer will appear and give them the price they seek. With a broad-index ETF, the very liquidity of the market assures the investor an accurate price with no hassles.

4. Tax advantages

In tax-deferred accounts this is less of an issue, but investors with taxable holdings can greatly benefit from using ETFs. The funds automatically buy and sell to track the index, but securities law allows them to do the buying and selling without triggering investment taxes on you, the holder of the security.

5. Ease

The great danger facing most retirement investors is their own emotions. As your portfolio grows larger, the stakes are higher. Active investors often take on unusual risks far too late in the process or they shut down and avoid all risk out of fear. Either reaction can be a serious problem for the long-term investor.

ETFs depersonalize your investments. Since you own everything, you are much less caught up in the drama of who is the CEO of which company, or the likely effect of some global political trend. Distance helps you keep things in perspective.

Retirement investing should be a simple, easy check-off on your to-do list, not a part-time job that creates stress in your life. ETFs are a great tool for making that simplicity happen.