ETF Benefits for Investors (2024)

Since debuting in 1993, the ETF industry has grown tremendously. Today, institutional and individual investors use ETFs in a myriad of ways to help meet their investment goals.

7 Key Benefits of ETFs

An ETF is a basket of securities that can be bought and sold in a single trade on a stock exchange. ETFs deliver diversified, low-cost, transparent, and tax-efficient exposure to assets across the globe. Understanding these ETF benefits can help you decide how ETFs may fit into your portfolio.

1. Portfolio Diversification

ETFs provide one of the easiest ways to diversify a portfolio. Much of the ETF landscape is comprised of index ETFs, which seek to track the performance of benchmark indexes containing many individual securities. In fact, ETFs first rose to prominence as effective passive investment vehicles.

By using ETFs to spread investments quickly across asset classes, geographies, and sectors, investors can lower the risk that weak returns from an individual security could hurt overall portfolio performance. And by increasing portfolio diversification, ETFs offer the potential for improved risk-adjusted returns.

2. Wide Variety of Investment Choices

As the ETF industry has exploded, so too has the number of market exposures available within ETFs. Investors can use ETFs to meet their investment objectives by conveniently accessing both broad and targeted exposures, including:

  • Asset classes – Equities, fixed income, commodities, currencies alternatives, multi-asset
  • Geographies – Global, regional, developed markets, emerging markets, single country
  • Sectors, industries, styles– Equity exposures such as biotech, insurance, transportation, growth, value, large/mid/small cap; fixed income exposures such as high yield, bank loan, aggregate
  • Investment themes – Multi-generational themes such as environmental, social & governance (ESG), technological advances, new consumer, urbanization
  • Factors, smart beta – Dividend, growth, momentum, size, value, volatility

3. Low Cost

Because most ETFs are passively managed, they typically have lower management fees and operating expenses compared to mutual funds. Transaction costs are minimized due to the low turnover of most ETFs and the indexes they track. When fees and expenses are low, investors can keep more of their returns.

How much lower are ETF costs? Both ETFs and mutual funds have an expense ratio, which includes management fees and the fund’s total annual operating expenses. The average expense ratio for index ETFs is lower than that of index mutual funds, historically 0.57% for ETFs versus 0.84% for mutual funds.1

Additionally, ETFs trade commission-free on many brokerage platforms, which can lower the total cost of owning an ETF.

4. Added Liquidity

In times of market volatility, liquidity is vital. Investors want to be able to buy and sell securities quickly, easily, and at an attractive cost. ETFs are unique in that their liquidity is supported by two trading markets.

In the secondary market, where most investors trade, ETF liquidity is provided by ETFs trading on an exchange. Because they trade throughout the day in the secondary market, investors can make timely investment decisions and quickly execute based on shifting market conditions.

Secondary market liquidity is enhanced by the primary market liquidity of each ETF’s underlying securities. This primary market liquidity is sometimes even greater than an ETF’s secondary market liquidity.

These two layers of ETF liquidity stem from how ETFs arecreated and redeemed.Creation involves buying all the underlying securities and wrapping them intothe exchange traded fund structure. Redemption is the process whereby the ETFis “unwrapped” back into the individual securities.

This process sets ETFs apart from other investment vehicles and is the mechanism that underpins many of their benefits, from improved tax efficiency to enhanced liquidity.

Source: State Street Global Advisors, June 4, 2023.

5. Transparency

The holdings of most ETFs are fully transparent and available daily. This disclosure means investors know what they own in real time, allowing them to make more informed investment decisions with greater accuracy.

6. Trading Flexibility

At any time during the trading day, ETF shares can be bought and sold through brokerage accounts at their current market prices, which may be slightly more or less than their net asset values (NAV). There are no minimum holding periods.

When trading ETFs, investors can employ a wide range of techniques to react to market movements, shift allocations, and deploy investment strategies, such as buying on margin, short selling, and placing limit orders.

The trading flexibility throughout the day offered by ETFs compares favorably to mutual fund shares, which are priced once at the end of the trading day. Mutual fund shareholders purchase and redeem shares at the fund’s closing NAV.

7. Tax Efficiency

Thanks to their tax-efficient structure, ETFs can help investors with taxable accounts keep more of what they earn. Because ETFs generally track market indexes, turnover is usually low, resulting in lower capital gains taxes.

ETFs also benefit from the ability to transfer securities in and out of the portfolio in the most tax-efficient manner, known as the in-kind creation and redemption process. When ETF investors sell their units on the exchange to other investors, the ETF portfolio manager does not need to buy or sell any of the ETF’s underlying investments.

In contrast, when an investor decides to sell shares of a mutual fund, the fund manager may sell a portion of the fund’s security holdings in order to deliver cash in the amount of an investor’s position. This sale may generate a realized taxable gain, and taxes on those gains are absorbed by the remaining shareholders in the fund.

Expand Your Knowledge of ETFs Even Further

Visit our ETF Education Hub to explore other ETF topics.

ETF Benefits for Investors (2024)

FAQs

What is the benefit of investing in an ETF? ›

ETFs can offer lower operating costs than traditional open-end funds, flexible trading, greater transparency, and better tax efficiency in taxable accounts. As with all investment choices there are elements to review when making an investment decision.

What are the benefits of ETFs to investors on Quizlet? ›

Exchange-traded funds can be traded during the day, just as the stocks they represent. They are most tax effective, in that they do not have as many distributions. They have much lower transaction costs. They also do not require load charges, management fees, and minimum investment amounts.

Which of the following is a benefit of an ETF? ›

ETFs can be less expensive to own than mutual funds. Plus, they trade continuously throughout exchange hours, and such flexibility may matter to certain investors. ETFs also can result in lower taxes from capital gains, since they're a passive security that tracks an index.

What are the positives and negatives of ETF? ›

Commissions and management fees are relatively low and ETFs may be included in most tax-deferred retirement accounts. On the negative side of the ledger are ETFs which trade frequently, incurring commissions and fees; limited diversification in some ETFs; and, ETFs tied to unknown and or untested indexes.

What are the benefits and risks of ETF? ›

Key Takeaways. ETFs are less risky than individual stocks because they are diversified funds. Their investors also benefit from very low fees. Still, there are unique risks to some ETFs, including a lack of diversification and tax exposure.

How good is investing in ETF? ›

ETFs make a great pick for many investors who are starting out as well as for those who simply don't want to do all the legwork required to own individual stocks. Though it's possible to find the big winners among individual stocks, you have strong odds of doing well consistently with ETFs.

How do investors make money from ETFs? ›

Dividends and Taxes

Though ETFs allow investors to gain as stock prices rise and fall, they also benefit from companies that pay dividends. Dividends are a portion of earnings allocated or paid by companies to investors for holding their stock.

What is ETF and their importance? ›

ETFs or "exchange-traded funds" are exactly as the name implies: funds that trade on exchanges, generally tracking a specific index. When you invest in an ETF, you get a bundle of assets you can buy and sell during market hours—potentially lowering your risk and exposure, while helping to diversify your portfolio.

What is the main benefit of investing in funds? ›

Mutual funds offer diversification or access to a wider variety of investments than an individual investor could afford to buy. Investing with a group offers economies of scale, decreasing your costs. Monthly contributions help your assets grow. Funds are more liquid because they tend to be less volatile.

What is the goal of ETF? ›

ETFs give you an efficient way to diversify your portfolio, without having to select individual stocks or bonds. They cover most major asset classes and sectors, offering you a broad selection.

Why are ETFs more efficient? ›

Equity and bond ETFs: Capital gains

Although similar to mutual funds, equity ETFs are generally more tax-efficient because they tend not to distribute a lot of capital gains.

What is one advantage of an ETF compared to an actively managed fund? ›

ETFs and index mutual funds tend to be generally more tax efficient than actively managed funds. And, in general, ETFs tend to be more tax efficient than index mutual funds.

Why is ETF not a good investment? ›

ETFs are subject to market fluctuation and the risks of their underlying investments. ETFs are subject to management fees and other expenses. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than their NAV, and are not individually redeemed from the fund.

What are the advantages of ETFs vs mutual funds? ›

ETFs typically track a specific market index, sector, commodity, or other asset class, exposing investors to a range of securities in a single investment. Their benefits include liquidity, lower expenses than mutual funds, diversification, and tax advantages. Investment Company Institute. "2023 Factbook."

Are ETFs good for short-term investing? ›

Key Takeaways

Not all ETFs offer the criteria for short-term trading, which includes high liquidity, cost efficiency, and price transparency. To maintain liquidity, traders should avoid ETFs that have a high percentage of off-exchange trades.

How does investing in ETF make you money? ›

Though ETFs allow investors to gain as stock prices rise and fall, they also benefit from companies that pay dividends. Dividends are a portion of earnings allocated or paid by companies to investors for holding their stock.

Is investing in ETF a good strategy? ›

Because of their low costs, diversification, and variety of choice, ETFs are among the best long-term investments on the market today. A popular long-term investing strategy is to buy and hold index funds with low expense ratios.

Why buy an ETF instead of a mutual fund? ›

ETFs typically track a specific market index, sector, commodity, or other asset class, exposing investors to a range of securities in a single investment. Their benefits include liquidity, lower expenses than mutual funds, diversification, and tax advantages.

Do ETFs have tax advantages? ›

ETFs are generally considered more tax-efficient than mutual funds, owing to the fact that they typically have fewer capital gains distributions. However, they still have tax implications you must consider, both when creating your portfolio as well as when timing the sale of an ETF you hold.

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