Since the dawn of the internet as we know it, Exchange Traded Funds, or more commonly ETF's have been a staple in the markets. Currently the ETF market is still growing strong as more and more continue to see the benefits. The general investor, though still has some concerns, questions, and misconceptions revolving around the product.
As someone who spends their days trading and studying ETF's, I frequently get a few of the same question from longer term investors. Today I will review the most common questions along with the answers I generally give.
"Aren't ETF's riskier than other investments?"
This question generally comes up when the markets get a little volatile. To a large degree, this concern stems from a relative lack of awareness about ETF's. First let's start with what an ETF is: a fund that trades like a stock. ETF's typically seek to track an index, providing investors with diversified access to a slice of the market at a low cost.
Market volatility often leads investors to consider exiting the market. Recent low returns and high volatility make for a more nervous environment for investors, with Brexit as a reminder of how quickly the markets can turn. Now, it's not that ETF's don't have risks. They are market instruments, and like stocks, their prices will be affected by a range of factors from interest rates to geopolitics and currency movements. That said, it's important to remember that these vehicles operate within a well-functioning, well-tested infrastructure with plenty of regulatory oversight.
"Why not just stick with an active fund rather than an ETF?"
Its not that you need to make a choice. In the age of low cost, online transactions, you can have both. Here is why you should consider ETF's in addition to your existing funds though:
- Most ETF's are built to provide a specific exposure to an index. This means that the focus of their exposures will not change over time. There's no risk of "style drift,". ETF's seek to do what they say on the label, which provides investors with clarity when building a portfolio and seeking diversification.
- Costs matter, particularly over time, and particularly in an environment where every penny counts. ETF's can help you keep more of what you gain. The savings from using ETF's can be substantial, where as active fees can erode portfolio returns over time.
- ETF's are easily accessible for all types of investors.
"Aren't ETF's more for investing in specific products?"
While ETF's can be specific to a sector or commodity, the majority of ETF's seek to track broad and liquid markets. Examples include U.S. stocks and bonds, and international and emerging markets stocks.
And yes, ETF's can also provide access to more specialized markets. Twenty years ago, it was the S&P 500 Index and single country funds. Today it is bonds, volatility and currency hedged funds.
