Benzinga’s goal is for you to understand how to take control of your finances, and providing information on exchange-traded funds (ETFs) helps to accomplish that. ETFs are unique investment tools that allow you to support a diverse grouping of companies, stocks or securities. Companies like Robinhood Markets Inc. curate a wide range of ETFs, and investing in these products allows you to adjust your focus, let Robinhood do much of the work for you and increase your net worth.
What Is an ETF?
An ETF is an excellent way to diversify your portfolio. While investing in a mutual fund asks you to trust the fund manager, an ETF is a single investment you can buy and sell at your leisure. Think of an ETF as a condensed mutual fund.
An ETF may allow you to invest in hundreds of companies — like the Vanguard 500 Index Fund ETF (NYSEARCA: VOO). Adding diversity to your portfolio protects you from dramatic downturns in the economy. For example, a sector or two of the economy may suffer significant losses, but the overall value of an ETF — like VOO — does not change dramatically.
How Do ETFs Work?
ETFs make money by adjusting their makeup, selling shares and hoping to increase the fund’s value. ETFs trade throughout the day and provide a high level of liquidity. Anyone can purchase shares in an ETF, increasing or decreasing their stake in the fund. Money not paid in dividends to shareholders goes back to the fund manager.
As the ETF adjusts its holdings, it must publish those holdings for public review. You know precisely what you are investing in at any time, and you can review the ETF’s activity. Even as the ETF hopes to earn money, it is accountable to the public, making your investment safer.
Buying ETFs on Robinhood
Investors are advised to only invest in an ETF they understand. When you open a Robinhood account, you must verify your identity and fund the account. Look through the list of available ETFs, choose the number of shares you wish to purchase and place your order. You can sell those shares at any time.
When choosing an ETF, there are several styles you should research and understand. Selecting the appropriate ETF depends on your comfort level and the value of that ETF. Consider investing in several ETFs for further diversity, including:
Index ETF: An index ETF attempts to mirror a particular index such as the Dow Jones or the NASDAQ. You can easily track the performance of that index and compare it to the ETF. If the corresponding index is strong, the ETF should be strong and vice versa.
Factor ETF: A factor ETF is under active management, hoping to outperform a certain index. Review the parameters of the ETF to determine whether you will make money given its unique goals.
Bond ETF: A bond ETF invests in government bonds around the world. A bond ETF offers even more diversity because governments issue bonds every year.
Commodity ETF: A commodity ETF invests in gold, silver, platinum and other commodities. Investors often retreat to precious metals such as these as a result of economic uncertainty.
Currency ETF: Currency ETFs invest in global currency, hoping to maximize their value by focusing on strong currencies or shorting as currencies lose value.
Inverse ETF: An inverse ETF invests in derivatives rather than stocks or bonds.
Leveraged ETF: A leveraged ETF attempts to outpace a particular index. Research the ETF’s investments and goals before buying.
Thematic ETF: A thematic ETF follows a theme rather than current market trends. A Thematic ETF might focus on eco-friendly companies, technology or other industries.
Benefits of an ETF
An ETF is easy to understand, research and review. You can sell an ETF at any time if you believe its makeup is no longer profitable or safe.
You can buy into an ETF easily by purchasing shares instead of buying into the fund without knowing its complete makeup. You can increase your stake if you are comfortable with the ETF and its value is growing. If the ETF’s performance suffers, you can sell your shares to avoid a significant loss.
Fees for buying or selling an ETF can be as low as 0.3%. Because you pay lower fees, you make more money when you sell for a profit. Your initial investment drops, reducing your overhead and increasing your net worth.
If you hold an ETF for less than a year, you do not pay capital gains taxes. Your income is taxed as regular income; you can use this advantage to constantly adjust your investments and save money.
You can trade an ETF at any time during the day as the price changes during that time. You can seek out a good price, buy quickly and wait for the price to peak in the future. Using this method, you can easily sell for a profit.
An ETF pays dividends, and those dividends add to your net worth. Remember that dividends paid by the ETF also are subject to holding qualifications. If the ETF holds a stock long enough, dividends paid on those stocks may be subject to capital gains taxes.
You can use Benzinga’s list of alternatives to diversify your portfolio that much more.
Make ETFs Part of Your Portfolio
An ETF is a simple way to diversify your investments, and its transparency adds further protection. Investing in an ETF through Robinhood is easy, helps increase your net worth and adds liquidity to your assets. Please return to Benzinga for more information on investing, personal finance and much more.
Frequently Asked Questions
Are ETFs a good investment?
Yes. ETFs reduce your risk, provide tax benefits and offer transparency that mutual funds simply do not possess.
What is the downside of ETFs?
An ETF provides you with dividends, but your income is taxed as normal income. Additionally, the lower risk of an ETF generally results in lower dividends.
Should you invest in ETFs?
Whether you should invest in ETFs depends on factors such as financial goals, risk tolerance and investment strategy. ETFs offer diversification, potential growth and reduced risk compared to individual stocks. They also offer flexibility, liquidity and lower expenses. Thorough research and understanding of specific ETFs are important before investing, and consulting with a financial adviser can help determine suitability.