The number of clients or customers you have may be uncertain, so it’s good to have savings to cover rainy days. But if you have a sum of money, you shouldn’t simply leave it in a bank account to collect a marginal amount of interest from your bank. It’s important to invest this money so that it can grow.
If wondering how to invest your money is top of mind, you’ve likely heard the term “ETF” or Exchange Traded Funds. This article goes over what an ETF is and why it’s so popular, as well as two kinds of ETFs: index and sector.
What is an ETF and why are they so popular?
An ETF is an easy and low-cost way to invest money. In a single product, they bring you a diversified portfolio of stocks and bonds which you don’t have to manage on a regular basis. This allows you to focus on your business.
In comparison, if you bought individual stocks, you would have had to do research into the companies that you wanted to invest in. If that stock ended up not doing well, it could take down a large part of your portfolio. With an ETF, however, if one of the stocks that’s part of the ETF goes down in value, it’s offset by the dozens of other stocks in that ETF.
Before ETFs, people commonly used mutual funds to find an easy and passive way to manage their money. Mutual funds are financial vehicles that are operated by money managers who allocate funds to make income and capital gains for its investors. However, these mutual funds are notorious for their high fees, which cut into how much you would make by purchasing one.
ETFs are different. Most notably, ETFs can be traded like a stock while a mutual fund can only be purchased at the end of a trading day. This means that you can buy and sell an ETF anytime that the market is open. ETFs are also often passively managed. This passive management means fewer fees going to a money manager, and thus greater returns for you, the investor.
An ETF is a great way to get a diversified portfolio with low fees. This gives you one of the best ways to get a sustainable return on your savings. Another important factor to keep in mind is what kind of ETF you’re purchasing.
An index ETF’s value is based on indexes such as the S&P 500 or the Dow Jones Industrial Average. And these indexes are based on pre-determined factors such as the largest 500 or largest 30 businesses in America. Indexes are a great way to track how the overall American/North America/Global economy is doing. By purchasing an index ETF, you’re betting that the economy will grow and progress.
Many in the investment community note that indexes in general often beat managed funds. This is because indexes do well in the long term. Managed funds may be up at one point and then down in the dumps two months later. Additionally, because indexes are based on relatively simple pre-determined factors, and are not actively managed, their fees are significantly lower.
Indexes can be purchased as a mutual fund or as an ETF. The primary advantage of an index ETF is that you can buy and sell it during trading hours. The major downside is that purchasing an ETF may result in paying a commission, but the commission is often under $10. So if you plan to invest your money lump sum, you’ve already mitigated this con.
A sector ETF tracks the stocks of a specific sector (usually mentioned in its name). These ETFs are passively managed by a fund, and they use indexes from services such as the S&P or Dow Jones. Sector ETFs are great for speculative or hedging purposes. That is, if you think a certain sector is going to do well or if you want to diversify away from a particular sector.
However, hypothesizing whether a certain sector will do well can be just as much research as hypothesizing whether a certain stock will do well. Therefore, if you don’t have the time and don’t want to do the research, it’s better to stick with an index ETF.
The world of ETFs is large and this article briefly skimmed the surface. If you want an easy way to manage your money, then putting your money into an index ETF may be the option for you. And if you’re willing to do a bit of research, sector ETFs could be a good option too.