Why Investing In Exchange Traded Funds Will Grow Your Wealth Fastest
As an investor, you have many options for where to put your money. You could invest your money into certificates of deposit at your bank, in mutual funds or even in stocks. While all of these choices have their place in investor’s portfolios, there is one type of investment that outshines all of them. It is exchange traded funds.
What makes exchange traded funds the cream of the crop for investors to grow their wealth? It all has to do with how exchange traded funds, also known as ETFs, work. By putting your money into these investment vehicles, you are able to keep more of your money and have it grow and compound faster than with any other option.
Let’s get started and see why ETFs will grow your wealth fastest.
What Are Exchange Traded Funds?
Exchange traded funds came on the scene in the United States in 1993. They are most akin to a mutual fund in that they are an investment vehicle that holds a basket of underlying stocks or bonds. For example, an S&P 500 Index ETF would hold a combination of the stocks that make up the S&P 500 Index.
The major difference however between a mutual fund and an exchange traded fund is that with a mutual fund, you can only buy or sell shares at the end of the day. With an ETF, you can trade it throughout the day.
For the most part, ETFs are passive investments that track the benchmark index that make up their underlying holdings. But in 2008, The Securities and Exchange Commission allowed for ETFs to be actively managed. However, the majority of ETFs available to trade are still primarily passively managed.
What Makes Exchange Traded Funds So Great?
Now that you know what an exchange traded fund is, what are the reasons that this investment vehicle is so great? Here are the reasons.
#1. Ability to trade throughout the day. With an ETF, you can buy or sell your shares at any time when the market is open. With a mutual fund, you can only buy or sell at the market close. So if the market has a volatile day, you are stuck holding your mutual fund until 4pm after the dust has settled.
For an investor with a large portfolio, a large market swing could see the investor lose a lot of money. With ETFs, you don’t have to worry about this as you can buy or sell when you need to.
#2. Instant diversification. Buying stocks is great. The only problem is that you have all your eggs in one basket as they say. In order to get diversified, you need to have more money to invest. With an exchange traded fund, buying one share will have you diversified.
This is all thanks to the ETF owning many underlying investments. Going back to the example of the S&P 500 Index ETF from above, buying one share means you now own shares in close to 500 companies.
#3. Trading fees. Since ETFs trade like stocks, most brokers charge a trading commission when you buy or sell shares. However, many have introduced no fee ETFs. Here, you can trade any ETF that falls into the category for free. In other words, you get the benefits of investing in a mutual fund without paying the trading commission on a stock.
Thanks to competition, most brokers now offer a few hundred no fee ETFs that you can invest in.
#4. Tax efficiency. If you invest in mutual funds you know that one of the biggest drawbacks is taxes. Regardless if you buy or sell any shares in a given year, chances are you will realize capital gains from the fund manager buying or sell shares of the underlying investments that make up the mutual fund.
If you are a high income investor, the taxes you owe on capital gains eats away at your investment. Luckily if you invest in ETFs instead, you don’t have to worry about this problem.
Because of how ETFs are structured, you rarely experience realized capital gains if you don’t buy or sell any shares. And in the event you do, the capital gains tend to be much smaller than what you would experience owning a mutual fund.
#5. Cost to own. Owning exchange traded funds are much less expensive to own compared to mutual funds. This tends to be because most ETFs are passively managed, keeping the expense ratios low.
As an investor, you pay this expense out of the performance of the ETF or mutual fund. The fees are taken from the top and you are left with any gain that still remains.
It makes sense then that the lower the fee you pay for an investment, the more of any gain you get to keep and grow your wealth with.
Final Thoughts
So there are the reasons why exchange traded funds will grow your wealth the fastest. By keeping more of your money invested and by being diversified from the start, you increase returns while keeping risk at bay.
Of course, other investment vehicles like individual stocks or certificates of deposit have a place in some investors portfolios, the best investment option of the majority of investors is exchange traded funds.
Note: This article originally appeared at Modest Money. The author is Jon Dulin. Jon writes for Money Smart Guides, a personal finance blog that helps readers get out of debt and start investing for their future. He has been investing since he was 16 and has learned a lot through the years. He uses these investment lessons to help him be a more successful investor today.
Category: ETFs
