When Investors Should Use ETFs

ETF Trends

Exchange traded funds can be used for various investing styles due to their flexibility and simplicity. However, financial advisors want investors to know how ETFs can be most efficient and when to consider other options.

“You could do all of your investing with the 1,000 or so ETFs, most of which use index-style strategies rather than active management. It’d very easy taking just a few clicks of the mouse with your online-broker – just like trading a stock. Fees are extraordinarily low and ETFs can be very kind come tax time,” Jeff Brown wrote for CNBC. [More Financial Advisors Using ETFs for Core Holdings]

Many financial advisors like ETFs and use them in their client portfolios. However, the need for more ETF education is evident, especially as more ETFs continue to hit the market with complex strategies. Advisors want investors to know when to use ETFs and when another tool may be more efficient. [Financial Advisors Fuel ETF Growth: Report]

Day traders and short term investors love ETFs for the tradability. They allow investors to move in and out of stocks seamlessly, any time of the day. Investors can also short sell and use options with ETFs, a feature that is not available with a mutual fund. [ETFs and Efficient Markets]

Long term investors can benefit from the low cost of an ETF even more, since they are employing a buy-and-hold strategy that will not incur extra brokerage fees. Day traders do risk incurring higher costs due to brokerage costs with each trade of an ETF.

ETFs are generally passively managed, meaning they track a selected index and hopefully match or exceed the returns of the selected stocks. A mutual fund does give investors the expertise of analysts and managers that will search for stocks and bonds which will generate alpha, reports Brown.

In general, active mangers have a hard time beating indices or comparable index funds. Actively managed funds cost more, too, because there is more overhead to account for.

“Over the long term, taking into consideration costs and taxes, active management does not outperform indexed products,” said Russell D. Francis, an advisor with Portland Fixed Income Specialists in Beaverton, Ore.

Investors should not write off one style or the other, since active strategies can be beneficial for some areas of the market, and passive investing serves others. For example, an ETF can be used as a core holding in a portfolio, while actively managed funds can enhance the strategy. Active management has been known to be useful in niche areas of the market, where thin trading and lack of attention can leave a bargain concealed, reports Brown.

“I think there are areas of the market that active management may be beneficial,” Matthew Reiner, a financial advisor with Capital Investment Advisors of Atlanta, said. Others favor active management for high-yield bonds, foreign stocks or small-company stocks.

Tisha Guerrero contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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