What are ETFs?
ETFs are popular investment vehicles traded on stock exchanges. They enjoy popularity among investors because they are not expensive, are tax efficient, have stock-like features, and are managed by professionals. If you are thinking of getting an ETF, you will hold stocks, bonds or commodities with an arbitrage mechanism that makes them relatively safer. Investing in this fund does not involve any research on your end and does not require you to manage it yourself. You can only get this type of fund from authorized broker-dealers such as Vanguard.
It can be simplified as a combination of a mutual fund or stock that can be sold or bought when the trading day ends. At the end of each day, the fund can have a valuation that is more than its net asset value but can also be lower than the net. However, this value does not veer too far from the original value of the fund.
ETFs have been available in the US since 1993 and in Europe since 1999. Traditionally, these investment vehicles were indexed funds, but by 2008, the Securities and Exchange Commission (SEC) in the US started authorizing actively managed ETFs – the fund that you are currently reading about.
Top 3 ETF Broker Comparison
Vanguard ETF Guide
Vanguard is a privately held company based in Malvern, Pennsylvania. It was founded by John C. Bogle in 1975. After decades as a registered investment advisor, the company now manages a whopping $5.1tn in assets. Because of its experience, it is now the second largest ETF provider in the world. Structured as a mutual fund organization, Vanguard Total Stock Market ETF is effectively owned by its customers, though the ownership is indirect.
Vanguard’s founder is responsible for creating the very first index fund for individual investors and has always been a supporter of low-cost investments. Bogle’s undergraduate thesis at Princeton focused on mutual funds, according to the company. In this study, Bogle found that mutual funds do not earn as much as stock market indices. By 1975, he founded Vanguard, and a year later he established what is now called the Vanguard 500 Index Fund. After the start of 1982’s bull market, other companies copied Bogle’s indexing model but failed miserably because they charged high fees. Vanguard kept growing, and by May 2017, the company launched a brokerage account in the UK. As a result, its competitors in the country suffered from drops in share value. Today, the firm has offices in Arizona, North Carolina, Australia, Europe and Asia. Due to its long history and reputation, there is no need for you to look for reviews on broker comparison sites to see if Vanguard is worth the money.
ETF Structure: Why ETFs Are a Combination of Mutual Funds and Stocks
To have a clearer understanding of ETFs, it is important to take a look at the structure. An ETF owns items referred to as assets, and these assets are usually stocks, bonds, gold bars and the like. Because ownership is divided among shareholders, people who invest their money in ETFs indirectly own the assets of the funds.
- If you are a shareholder, you are likely to get an annual report along with a share of the profits, often referred to as interest or a dividend. You may also be able to get a residual value of the fund once it is liquidated.
- Since ETFs are traded within every trading day, your ownership of the shares of an ETF fund can be bought or sold while the market is open. In many ways, ETFs are like mutual funds except for the fact that they are traded throughout the day as if they are stocks.
- It is evident that they are some of the most appealing types of investments around. This means that getting a share from a reputable ETF broker-dealer is a good idea in general.
While ETFs are comparatively safer than other types of investments, there are still risks involved, though experts admit that these risks are minimal.
The Benefits of ETFs
ETFs have many investment uses. These include easy diversification, which is an important ingredient for successful investing. Traders and investors know how important it is to diversify one’s portfolio, but doing that on your own involves a lot of research and learning new things. Relying on professionals or a broker-dealer with decades of experience will not only cut down costs but will also relieve you of the anxiety of wondering whether you should sell a particular asset or not.
If you do not have a lot of capital or would like to reduce your expense ratios, investing in an ETF is a good option. As mentioned earlier, ETFs are tax efficient, which means that you will not be losing a lot of money paying for your trades. With all of these uses, it would seem that ETFs are near perfect, especially when you consider the fact that they have the features of ordinary stocks. Why are they much cheaper than other types of investments though? Most ETFs are not managed actively, and you even get to save more money because they have lower expenses. In fact, most ETFs do not have 12b-1 fees.
Since they do not require deep pockets, these investment vehicles are a great option for individuals who want long-term investments. Apart from this, you can even use them for your market timing strategies.
What You Need to Get Started
To trade ETFs through Vanguard ETF, you will need to open a brokerage account with the company. To do this, you just need to go to Vanguard’s website and follow the guide below. With scammers getting more creative, it is important to make sure that you go to the right website though and that you are actually dealing with the right company.
- Choose your account: Vanguard ETF offers general accounts for individuals as well as joint accounts. It also offers Roth IRAs and traditional IRAs, custodial accounts for a child, and SEP-IRA accounts.
- Your settlement fund: The settlement fund for your account is Vanguard’s Federal Money Market Fund.
- Open your account: Opening an account with the company only takes around ten minutes. You will need to provide information such as your bank account numbers and your social security number.
According to Vanguard, your money market settlement fund does not have any minimum investment. This is the same for your initial investment for your ETFs. All you need to provide is the price per share. You can also start with your trades right away but will need to make the deposit within two business days to pay for the trades.
Bear in mind, owners of new brokerage accounts need to deposit money into their settlement fund before they have the ability to trade.
Hidden Risks and Costs
While the risks and costs of ETFs are relatively lower than with other types of funds, these investment vehicles are not immune to market volatility and costs. Like any other type of investment, there are risks involved, and it is important that you are aware of them. These risks include market risk, risks when it comes to trading, liquidity, composition, methodology, tracking error, taxes, closure, hype, and counterparties.
- ETFs are not immune to market risks and can never avoid falls if the underlying asset is falling. While ETFs can mitigate risks, market risks are more difficult to cushion as they cannot be mitigated directly.
- Trading risks, on the other hand, involve the total cost of your ETF. There will still be commissions, sales charges, direct trading costs, and even market impact costs that you will need to shoulder.
- Apart from the two potential problems mentioned above, it is also important for every investor to understand the liquidity of ETFs. They are basically as liquid as the stock, commodities, or bonds that they hold.
If you make the decision to actively put your money in unpopular ETFs, then you will be exposing yourself to these types of risk – it is an unavoidable aspect of this particular type of investment.
The composition of your ETF determines its success. If the stocks or commodities wrapped in the ETF are not as good as another, then you are at risk of losing money. While these risks are minimal, it is still important to protect yourself from them. If you are unsure on how you should go about it, you should consult a professional. Apart from composition risk, your ETF can also be exposed to methodology risk. Some ETFs are not intuitive, which can be problematic. Your oil ETF, for example, is not an indicator of crude oil prices. Experts note that understanding these risks is important to lessen the possibility of losing money. If the risks are not understood, then it is best to learn more about them and how you can avoid them.
Another hidden risk involves taxes. While you generally do not pay as much as you would when trading stocks, the Internal Revenue Service will still tax your ETF holdings no matter how long you have had them. You can also be exposed to counterparty risks and be left hanging if an unsecured debt is no longer backed by a bank. Joining the hype of a particular ETF can also threaten your capital.
What To Keep In Mind
Since it is relatively easy to put up a company that offers ETFs, you will come across with smaller players. This can be a good thing, at least for the economy, but can be bad for your investment. Smaller players are still unstable and rarely have the funds to support the ETFs they have on offer. If the business does not make enough, the company may have to shut down and take some of your money with it. Larger providers such as Vanguard are a better choice because they can absorb costs while your fund grows. It is important to be cautious when it comes to picking a dealer because it can result in risks that could have been avoided in the first place.
You should also keep in mind that not all exchange traded funds are created equal. Aside from the nature of their underlying assets and their profitability, some have higher fees. While fees, taxes, and other costs were already discussed, there are other charges that you should be aware of. Since its dramatic rise, some actively managed ETFs are now just as pricey as other modes of investment. This is the sad truth about popular investments and the very reason why you should scrutinize all charges before you buy.
ETFs, in general, are good investments, but like any other investment, there are also risks involved. The presence of risks in ETFs must be reiterated though, because they are generally very appealing and quite popular to the point where you can forget that they also have disadvantages. It is important to point out though that the advantages outweigh the disadvantages when compared to other types of investments. To ensure that you do not put your capital at risk while dealing in ETFs, you need to mitigate the various risks mentioned above. You also need to make sure that you get an account from a broker or dealer with people who will be able to help you make sound decisions. Researching ETFs and studying how they work would be beneficial for beginners and experienced investors alike. Asking for advice from an investment professional is also a good idea when you are planning to open a brokerage account.