We have found that many individuals we encounter are so busy with different elements of simply living life, they don’t always have great awareness of financial matters or investing. These individuals may be well-advised to hire a professional financial advisor to help them better understand investing, financial planning, tax planning, estate planning, retirement savings, college savings, and more. There’s too much to lose if one doesn’t get this right!
ETF Strategies: Doing Some Groundwork
In addition to working with an advisor, individuals should have some basic knowledge of investment topics as they determine what kind of investment strategies make sense for them. One investment option that investors may be lacking information about is ETFs, or exchange-traded funds.1 ETFs are investment products that typically own a portfolio of stocks, bonds and/or other securities. Investors buy these ETFs on stock exchanges through brokerage accounts, similar to the way they buy stocks.
Here are three questions investors can consider as they talk with their financial advisor about ETFs:
- What market exposure will I be getting by owning an ETF? With nearly 2,000 ETFs available for purchase in the U.S., it’s important to know what specific element of the market you will be adding to your portfolio. Some ETFs target a specific industry or sector of the market, such as technology, brokerage, etc. Others target a country or region of the world, while some target a specific method of investing. It’s crucial to know what it is that you’ll be accessing with the ETF. One of the distinct features of using an ETF is that it provides daily transparency, which allows for investors to see exactly what they own on any given day – this can really help when thinking about your asset allocation.
- What costs are associated with ETF strategies? The first cost to be aware of is simply the commission to purchase the ETF. Another cost you should be aware of is the cost of the ETF itself, also known as the expense ratio. All ETFs charge fees, and you should be aware of the total fees charged to cover the cost of picking the securities and the operational costs of servicing the strategy. It makes sense to research whether or not the total expense ratio charged is competitive relative to comparable ETF strategies. Lastly, there is a cost called the “spread,”2 which is somewhat complicated. Typically, the spread is a few pennies to several cents of additional cost that are added to the price of ETF trades on the exchange. This is used to cover the costs to create new shares of the ETF. It is also used to compensate market makers3 for the risk they take in their efforts to creates an efficiently traded market for the ETF. The lower the spread, the lower the cost of the ETF purchase for the investor. “Total Cost of Ownership: Breaking Down Secondary Market Spread” provides more information on this topic.
- How will an ETF fit within my overall portfolio? Careful consideration has to be paid to how each ETF fits within a portfolio. Like all investments, ETFs involve risk. Investors can talk with their financial advisor or an investment professional about the variety of outcomes an ETF can aim for, including return-seeking, risk reducing, diversification enhancement, etc. Many financial advisory firms are able to run each holding within the portfolio through sophisticated asset allocation tools to demonstrate the level of risk. All of this is extremely useful to understanding how each ETF may contribute to the broader portfolio-level goals.
Inflows in to ETF investment structures topped $280 billion in 2016.4 We believe that activity in this space is likely to continue. As you consider if an ETF strategy might help you achieve your financial goals, working with a financial advisor can increase your understanding of the available options, opportunities, and risks.
1 An exchange-traded fund, or ETF, is a marketable security that tracks an index, commodity, bonds, or a basket of assets like an index fund. ETFs trade like common stock on a stock exchange and experience price fluctuations throughout the day as they are bought and sold.
2 A spread is the difference between the bid and the ask price of a security or asset.
3 The term market maker refers to a dealer in securities or other assets who undertakes to buy or sell at specified prices at all times.
4 Roy, Sumit. “2016 ETF Inflows Set New Record Above $280B.” etf.com. 9 Jan. 2017. Web. www.etf.com/sections/weekly-etf-flows/weekly-etf-flows-2016-12-29-2016-12-23
Investing involves risk, including the risk of loss ETFs trade like stocks, are subject to investment risk, and will fluctuate in market value. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than the ETF's net asset value.There is no assurance that any investment will meet its performance objectives or that losses will be avoided.
Diversification does not guarantee a profit or protect against a loss.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.
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