Explore the advantages of ETFs and strengthen your portfolio
Before talking about the advantages of ETFs. Let’s talk a bit about Mutual Funds.
For several years, traditional Mutual Funds have provided investors with the ease of building a diversified portfolio without choosing single security at a time.
These funds have provided retail investors like you and me far-reaching diversification and these funds have provided retail (non-professional) investors far-reaching diversification and specialized management at a relatively lower cost. Exchange-traded funds (ETFs) take these benefits to a whole new level. ETFs have several advantages associated with them.
Let’s see how each of them pans out for our use.
Advantages of ETFs
ETFs on similar lines to Mutual Funds offer a wide range of diversification. The general tendency of investors is to get concentrated in any particular sector without having any requisite knowledge of that sector, which results in lesser realized gains than actual potential.
This psychological problem can be countered by investing in ETFs, managed professionally and diversified to minimize risk and maximize growth. Nowadays, ETFs are available in a variety of types and orientations covering all major asset classes and sectors.
Global ETFs, local market ETFs, Industry-specific ETFs and market niches provide investors access to industries where it may be cumbersome to buy and sell individual stocks and bonds.
Diversification also leads to risk management as the concentration in a given sector without expertise is avoided. ETFs can be a great tool to hedge your portfolio against any untoward market runs.
ETFs typically are low-cost instruments compared to traditional mutual funds because of their very nature. While trading ETFs, fewer hands and minimal paperwork is required; naturally, the costs fall compared to selling mutual funds.
Thus, the expense ratio for ETFs is lower than other such securities, hence leaving you with a more significant amount of total capital in return compared to others.
For instance, the Vanguard REIT Index Fund Investor Shares (VGSIX) has a redemption fee of 1% if held for less than one year compared to Vanguard REIT ETF (VNQ), which has the same portfolio and has no redemption fees.
ETFs are traded openly in the stock market and hence are liquid compared to mutual funds, which aren’t. Redeeming a mutual fund is a very tedious process and requires a lot of time, whereas ETF-selling is easy at any point of the day.
Mutual fund settlement takes place only once a day after the market timings, and this delay can prove costly.
Most ETFs are very transparent in their operations and disclose their holding almost daily, which helps the investor make sound decisions about holding the ETFs in their portfolio.
Active semi-transparent ETFs reveal their complete portfolio holdings monthly or quarterly with a lag. Moreover, ETFs are simple products that can be easily understood by a layman investor, unlike some complex financial products except some specialized ETFs like inverse and leveraged ETFs.
With the help of a single transaction, the investor can buy or sell a bunch of underlying securities without the hassle of purchasing each stake individually.
A commodity derivative market is a place where there is restricted access to a few people and institutional investors due to the high costs of owning them.
On the other hand, ETFs have enabled retail investors to be a part of this segment at low prices. Thus, your portfolio gets new exposures with the help of such ETFs.
ETFs also come with an added advantage of tax benefits compared to mutual funds. The tax benefits in the ETFs are due to the very working of the ETFs. The swap agreements between the fund and AP reduce the tax liability for the investors.
The capital gains tax on ETFs is due to selling the ETF, whereas, in a mutual fund, the tax liability is on the investor during the entire life of the holding.
There are several advantages of making ETFs a part of your investment portfolio. Besides rock-solid investments like equities, mutual funds and derivatives, ETFs are a financial tool that should be part of your investing arsenal, which increases the firepower of your portfolio manifold!