Is Investing in ETF good or bad?
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.
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.
For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.
Leveraged and inverse ETFs are designed for short-term trading and use complex strategies. These ETFs amplify market movements and can lead to substantial losses if they do not perform as expected. In short, they are riskier and may not be suitable for long-term investors.
A mutual fund or ETF tracking the same index will deliver about the same returns, so you're not exposed to more risk one way or the other.
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.
ETF | Assets Under Management | Expense Ratio |
---|---|---|
Vanguard Information Technology ETF (VGT) | $70 billion | 0.10% |
VanEck Semiconductor ETF (SMH) | $16.3 billion | 0.35% |
Invesco S&P MidCap Momentum ETF (XMMO) | $1.6 billion | 0.34% |
SPDR S&P Homebuilders ETF (XHB) | $1.8 billion | 0.35% |
Low Liquidity
If an ETF is thinly traded, there can be problems getting out of the investment, depending on the size of your position relative to the average trading volume. The biggest sign of an illiquid investment is large spreads between the bid and the ask.
It is unlikely for its asset to go up 100% in a single day and so, an ETF can't become zero. An ETF follows a particular index and the securities are present at the same weight in it. So, it can be zero when all the securities go to zero.
Stock-picking offers an advantage over exchange-traded funds (ETFs) when there is a wide dispersion of returns from the mean. Exchange-traded funds (ETFs) offer advantages over stocks when the return from stocks in the sector has a narrow dispersion around the mean.
What is the 30 day rule on ETFs?
If you buy substantially identical security within 30 days before or after a sale at a loss, you are subject to the wash sale rule. This prevents you from claiming the loss at this time.
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.
For ETFs held more than a year, you'll owe long-term capital gains taxes at a rate up to 23.8%, once you include the 3.8% Net Investment Income Tax (NIIT) on high earners. If you hold the ETF for less than a year, you'll be taxed at the ordinary income rate.
A leveraged ETF is a fund that uses financial derivatives and debt to amplify the returns of an underlying index. Certain double or triple-leveraged ETFs can lose more than double or triple the value change of the tracked index. Therefore, these types of speculative investments need to be carefully evaluated.
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.
If you're paying fees for a fund with a high expense ratio or paying too much in taxes each year because of undesired capital gains distributions, switching to ETFs is likely the right choice. If your current investment is in an indexed mutual fund, you can usually find an ETF that accomplishes the same thing.
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.
Basic trading choices for ETFs or stocks
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.
Also, beyond an ETF share price, there is no minimum amount to invest, unlike for mutual funds. Any broker can turn an investor into a new ETF holder via a straightforward brokerage account. Investors can easily access the market or submarket they want to be in.
What is the safest ETF to invest in?
- Vanguard S&P 500 ETF (VOO -0.83%) ...
- Vanguard High Dividend Yield ETF (VYM 0.7%) ...
- Vanguard Real Estate ETF (VNQ 0.29%) ...
- iShares Core S&P Total U.S. Stock Market ETF (ITOT -0.8%) ...
- Consumer Staples Select Sector SPDR Fund (XLP 0.86%)
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.
Symbol | Name | 5-Year Return |
---|---|---|
FNGO | MicroSectors FANG+ Index 2X Leveraged ETNs | 43.94% |
TECL | Direxion Daily Technology Bull 3X Shares | 34.92% |
SMH | VanEck Semiconductor ETF | 30.83% |
ROM | ProShares Ultra Technology | 29.51% |
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.