Do ETFs Fit Your Investment Strategy?
Planning for retirement? A well-balanced portfolio is key to long-term financial security. ETFs can play a pivotal role in your portfolio, offering diversification and flexibility to match your goals. In this guide, we’ll explore ETFs, how they compare to other investments, and how they fit into a smart investing strategy.
Knowing your risk tolerance helps you choose assets that align with your future financial goals. While ETFs are just one option, they can provide an accessible and efficient way to grow wealth over time. In this article, we will define ETFs, compare them to stocks and bonds, explore different types, and discuss their advantages and disadvantages in a diversified portfolio.
What is an Exchange-Traded Fund (ETF)?
An ETF, or exchange-traded fund, is a professionally managed investment fund that holds a mix of stocks, bonds, or other assets. Like individual stocks, ETFs are traded on the stock exchange throughout the day, offering liquidity and flexibility.
ETFs are typically designed around a specific strategy or market sector, such as technology or energy. They allow investors to diversify their portfolios without purchasing each asset separately. Unlike mutual funds, which are priced once daily, ETFs trade throughout market hours with fluctuating prices, allowing for real-time price changes and increased trading flexibility.
Since the first ETF launched in the 1990s, these funds have grown in popularity in the U.S. By 2021, ETFs surpassed mutual funds in assets under management, thanks to their lower internal expenses, tax efficiency, and greater trading flexibility.
There has been a significant rise in cash flowing into ETFs in recent years.
Source: Investopedia
How Do ETFs Work?
ETFs work by offering investors a simple way to diversify their portfolio with a single trade, while gaining exposure to a wide range of assets. Many ETFs track the performance of specific indices, like the S&P 500, giving a cost-effective method for broad market investment.
Most ETFs are passively managed, aiming to mirror the performance of a benchmark index rather than outperform it. On the other hand, actively managed ETFs are overseen by portfolio managers who make investment decisions and adjust the securities within the fund to meet specific investment goals.
What’s the Difference Between ETFs, Mutual Funds, and Stocks?
Though stocks, ETFs, and bonds are common investment opportunities, each serves a different purpose and comes with varying risk levels. Here’s a comparison to help you understand their unique characteristics.
| Investment | Definition | Risk Level | Pros | Cons |
|---|---|---|---|---|
| Stocks | Ownership in a company; shareholders benefit from profits through dividends and stock appreciation. | High | Can offer higher returns than market indexes. Best suited for money you never plan to spend. | Much higher risk of total loss and more volatility than diversified strategies. |
| ETFs | A collection of assets (stocks, bonds, etc.) that trade on stock exchanges. | Varies by type (Low to High) | Provide diversification, often at a lower cost, and offer liquidity and flexibility. | Actively managed ETFs tend to have higher fees, and capital gains taxes may apply upon sale. |
| Bonds | Loans made by investors to companies or governments in exchange for principal repayment plus interest. | Varies by type (Low to Moderate) | Less volatile, offering stability; good for short-term goals or investors with low risk tolerance. | Can offer lower returns than stocks, and early withdrawal from certain bonds may incur penalties. |
What are the Different Types of ETFs?
- Stock ETFs A collection of stocks that trades like an individual stock and can be bought or sold throughout the day. These ETFs offer diversification at a lower operational cost than purchasing individual stocks.
- Bond/Fixed-Income ETFs Hold a portfolio of bonds, offering exposure to different fixed-income strategies. Like stock ETFs, they are either passively or actively managed and trade on exchanges but typically don’t have a maturity date.
- Sector & Industry ETFs ETFs that focus on specific industries or sectors. This allows investors to gain exposure to a particular sector, such as technology, healthcare, or energy, rather than a broader market.
- Commodity ETFs These ETFs provide exposure to popular raw materials such as gold, oil, and agricultural products through physical holdings or futures contracts.
- International ETFs Invest in stocks of companies outside the U.S. This provides exposure to global markets and diversification beyond domestic investments.
- Thematic & ESG ETFs These ETFs focus on companies with similar business values or that align on important issues such as clean energy, water, or gender diversity.
What are the Advantages and Disadvantages of ETFs?
Like any investment, ETFs come with both advantages and disadvantages. Here are some key points to consider:
| Advantages of ETFs | Disadvantages of ETFs |
|---|---|
| Strategically Diversified: ETFs include a mix of stocks and bonds, reducing risk by spreading investments across various assets. | Potential Fees: Depending on the institution and ETF, there might be a trade commission fee. |
| Less Risk: Spreading your investment over dozens or hundreds of companies will significantly lower risk. | Bid/Ask Spread: ETFs that don’t trade frequently may have a wider bid-ask spread, meaning the difference between what you’re willing to pay and the price someone is willing to sell for could be higher, impacting your overall cost. |
| Lower Fees: ETFs often have lower operating fees than other investments like mutual funds. | Subject to Market Risk: ETFs are subject to market volatility, meaning their value can fluctuate significantly. |
| Easy to Trade: ETFs can be bought or sold during market hours (when a stock can be sold). | Susceptible to Errors: Some ETFs may not perfectly match the performance of their target index due to tracking differences. |
| Tax Efficient: With fewer “taxable events,” ETFs tend to be more tax efficient than other investments. | Limited Control: ETF managers select the holdings, so you don’t choose individual stocks—this can be a pro or con depending on your strategy. |
| Combined Benefits: ETFs combine the diversity benefits of funds with the liquidity and flexibility of stocks. |
What Should I Consider When Investing in ETFs?
Choosing the right ETFs is an important decision. To make the best choice, conduct thorough research, consult with a financial advisor, and consider the following steps:
- Choose the Right ETF for Your Goals and Desired Outcome
Growth, income, or diversification–what are the goals you want to achieve? - Choose an ETF Based on Your Investment Style
Does your investment style align with your timeline and risk tolerance? - Determine if You Want Active or Passive Management
Do you prefer an actively managed ETF with a portfolio manager or a passively managed ETF that tracks an index? - Evaluate Expense Ratios and Holdings
Do the ETFs you’re interested in sell at a premium or discount? How will this impact future returns and trading opportunities? - Decide Where to Buy
- Online Platform Broker
Do you want personalized access to your investments with control through an online platform? - Robo-Advisor
Would you prefer an automated system that monitors and adjusts your portfolio for you? - Traditional Financial Advisor
Do you want more personalized, in-depth management and assistance from an experienced professional?
- Online Platform Broker
- Choose the Right ETF for Your Goals and Desired Outcome
How Do I Start Investing in ETFs?
- Open a Brokerage Account & Find a Financial Advisor
A brokerage account allows you to buy and sell securities. While opening one might seem daunting, the process is straightforward and can be done online, similar to setting up a bank account.Once your account is set up, research and compare different financial advisors and/or brokers to find the best fit for your needs. When choosing a financial advisor and/or broker, compare fees, trading platforms, and available features. If you’re a first-time investor, look for professionals who offer educational resources to guide you.
- Select Your Funds
Explore different funds and see how ETFs can help you achieve your financial goals. You should invest in a specific industry, region, or theme. Consider your options, assess costs, and ensure they align with your investment strategy. - Decide How to Invest
Determine how much and how often you want to invest. You can make regular contributions over time or invest a lump sum up front. - Talk to Your Financial Advisor
Discuss your risk tolerance and selected ETFs with your financial advisor, who will guide you through purchasing.
- Open a Brokerage Account & Find a Financial Advisor
Conclusion
Navigating ETFs can be complex and time-consuming, whether you’re a beginner or an experienced investor. A trusted financial advisor can simplify the process, develop a strategy tailored to your goals, and ensure your investments align with your risk tolerance and retirement timeline.
At Toberman Becker, we help you make informed decisions and select the ETFs that best fit your investment strategy. Our team will guide you through your options, answer key questions, and keep you on track for the retirement you deserve.
Take the next step toward smarter investing. Schedule a complimentary call with Toberman Becker Wealth today.
ETF FAQ
Our team is here to help. Whether you’re exploring ETFs or ready to integrate them into your portfolio, we’ll walk you through your options, answer your key questions, and ensure you stay on track. Feel free to reach out–we’d be happy to discuss next steps.
Michael is a highly knowledgeable and experienced partner at Toberman Becker in St. Louis. With his expertise in investment management, behavioral finance, and retirement planning, Michael is dedicated to providing his clients with the best financial guidance possible.
Having worked with clients on complex estate planning and developing investment strategies for a team of advisors, Michael’s experience spans across various areas of financial planning. What truly sets him apart is his unyielding desire to acquire knowledge for the betterment of his clients. At Toberman Becker, this commitment to continuous learning is the foundation upon which exceptional client experiences are built.
Michael earned a Bachelor of Science degree in Finance and Banking from the University of Missouri – Columbia. Additionally, he holds designations as a Chartered Financial Analyst (CFA) charterholder and Certified Financial Planner (CFP).
Beyond his professional achievements, Michael enjoys a fulfilling personal life in St. Louis. Living with his wife, Lindsey, and their beloved dog, Birk, he finds joy in activities such as golfing together and exploring local restaurants.