Exchange traded funds are quickly becoming an investor favorite due to their diversification and liquidity benefits. Retail investors are able to use ETFs with ease which has contributed to the quick rise in assets under management since their debut in the U.S. in 1993.
“There are currently 1,234 funds available from 38 different providers, but the marketplace is dominated by the top three providers. Blackrock, State Street, and Vanguard control approximately 83% of the U.S.listed ETF market,” David Fabian, Chief Operations Manager of Fabian Capital Management, wrote in a recent commentary. [How Investors Should Use ETFs]
Diversification is built into an ETF since it is essentially a basket of stocks that trades on an exchange. There are plain-vanilla, broad based ETFS that track an entire index such as the S&P 500, or funds that track specific sectors or asset classes. Many ETFs track an underlying passive index. [Inside ETFs Conference: Look Out Mutual Funds]
Instant liquidity and transparency are other built-in features of ETFs. The ability of an ETF to trade with the ease of a single stock any time of the day is useful for both long term investors and day traders. The transparency allows holdings to be viewed in real time, rather than just at the close of a trading day, so an investors knows exactly what they are investing in. [3 Misconceptions About ETFs]
Low-cost risk management is a newer concept that ETFs have contributed to many portfolios. Since an ETF trades similar to a single stock, an investor can place a stop loss on one to avoid excessive downside risk. The average ETF costs anywhere from 0.05% to 0.65% , compared to a traditional mutual fund that generally costs at least 1.0%.
Brokerage fees can add up when trading ETFs, so investors should keep their number of trades low. Every trade is a transaction that costs money, so it is important to keep trades to a minimum to avoid excessive fees. [ETFs Vs. Index Funds]
Tax efficiency can be a result of low portfolio turnover. Since many ETFs are buy-and-hold products, the tax impact is much less than what a traditional mutual fund incurs. Investors that hold capital in taxable accounts can really benefit from this feature, Fabian said.
Tisha Guerrero contributed to this article.