What makes an ETF successful?
The benefits of the ETF wrapper relative to other investment vehicles – transparency, liquidity/intraday tradability, low cost and tax efficiency – offer what we call structural alpha to the end investor. That is one way in which an ETF solves an investor problem.
Ultimately, investors choosing an ETF need to ask 3 questions: What exposure does this ETF have? How well does the ETF deliver this exposure? And how efficiently can I access the ETF? Look at the ETF's underlying index (benchmark) to determine the exposure you're getting.
Since the job of most ETFs is to track an index, we can assess an ETF's efficiency by weighing the fee rate the fund charges against how well it “tracks”—or replicates the performance of—its index. ETFs that charge low fees and track their indexes tightly are highly efficient and do their job well.
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.
Positive aspects of ETFs
The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs versus like mutual funds, and potential tax benefits.
At any given time, the spread on an ETF may be high, and the market price of shares may not correspond to the intraday value of the underlying securities. Those are not good times to transact business. Make sure you know what an ETF's current intraday value is as well as the market price of the shares before you buy.
The single biggest risk in ETFs is market risk. Like a mutual fund or a closed-end fund, ETFs are only an investment vehicle—a wrapper for their underlying investment. So if you buy an S&P 500 ETF and the S&P 500 goes down 50%, nothing about how cheap, tax efficient, or transparent an ETF is will help you.
Holding an ETF for longer than a year may get you a more favorable capital gains tax rate when you sell your investment.
Hold ETFs throughout your working life. Hold ETFs as long as you can, give compound interest time to work for you. Sell ETFs to fund your retirement. Don't sell ETFs during a market crash.
Key Takeaways. ETFs are considered to be low-risk investments because they are low-cost and hold a basket of stocks or other securities, increasing diversification. For most individual investors, ETFs represent an ideal type of asset with which to build a diversified portfolio.
How do you earn a positive return from an ETF?
Most ETF income is generated by the fund's underlying holdings. Typically, that means dividends from stocks or interest (coupons) from bonds. Dividends: These are a portion of the company's earnings paid out in cash or shares to stockholders on a per-share basis, sometimes to attract investors to buy the stock.
You expose your portfolio to much higher risk with sector ETFs, so you should use them sparingly, but investing 5% to 10% of your total portfolio assets may be appropriate. If you want to be highly conservative, don't use these at all.
You place an order with your broker or online to buy, say, 100 shares of a certain ETF. Your order goes to the stock exchange, and you get the best available price. Limit order: More exact than a market order, you place an order to buy, say, 100 shares of an ETF at $23 a share. That is the maximum price you will pay.
The single biggest risk in ETFs is market risk.
As such, ETFs remove single-stock risk, or the risk inherent in being exposed to just one company. The diversification of index funds across many securities can dilute the potential negative impact of poor performance of any one security.
ETFs offer numerous advantages including diversification, liquidity, and lower expenses compared to many mutual funds. They can also help minimize capital gains taxes. But these benefits can be offset by some downsides that include potentially lower returns with higher intraday volatility.
Leveraged ETF prices tend to decay over time, and triple leverage will tend to decay at a faster rate than 2x leverage. As a result, they can tend toward zero.
Experts agree that for most personal investors, a portfolio comprising 5 to 10 ETFs is perfect in terms of diversification.
In theory, if Vanguard went bankrupt, your assets within the ETF should be safe, as they're technically yours held in trust by Vanguard. So if Vanguard collapsed, then what would likely happen would be that another manager would take over the ETF, or the assets would be sold off and you'd be paid out.
As the old cliché goes, you do not want to put all your eggs into one basket. An ETF can guard against volatility (up to a point) if some stocks within the ETF fall. This removal of company-specific risk is the biggest draw for most ETF investors.
How much should I invest in ETFs per month?
Some experts recommend at least 15% of your income. Setting clear investment goals can help you determine if you're investing the right amount.
| Symbol | Name | 5-Year Return |
|---|---|---|
| SPYG | SPDR Portfolio S&P 500 Growth ETF | 14.43% |
| VOOG | Vanguard S&P 500 Growth ETF | 14.38% |
| IWL | iShares Russell Top 200 ETF | 14.36% |
| LRGE | ClearBridge Large Cap Growth ESG ETF | 14.29% |
Q: How does the wash sale rule work? If you sell a security at a loss and buy the same or a substantially identical security within 30 calendar days before or after the sale, you won't be able to take a loss for that security on your current-year tax return.
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
Visit your My NerdWallet Settings page to see all the writers you're following. RDIV and SPYD have some of the highest yields of any high-dividend ETF. It's possible to live off the income from high-dividend ETFs, but it may take some planning.
