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ETFs Explained

Remember those cheesy Apple commercials that used to always say "there's an app for that" back in 2009?


Well, much like there are apps for everything under the sun, there are EXCHANGE TRADED FUNDS (ETFs) for almost everything.


ETFs have definitely grown in popularity over the years; understandably so. This article will explain what ETFs are, and how they work.


Simply stated, ETFs are investments that track (mirror) the performance of a certain type of investment or group of investments.


One of the most popular ETFs in the entire world is the $SPY ETF, offered by SPDR. This ETF MIRRORS the performance of the S&P 500 (the largest 500 publicly traded companies in the US). If you own the $SPY ETF, you can reasonably expect its performance to match that of the S&P 500 over the same period of time that you hold it.


Here's an example. If the S&P 500 grows by 8% in a year, $SPY will also be expected to grow by 8%.


How does this work? The creation of ETFs is rather complex; we won't get into that. The main thing you need to know is the investment company (fund) that offers the ETF actually purchases A LOT of the underlying investment(s) in order to have the fund match the performance of investment(s) being tracked.


$SPY is only one example. In fact, there are a lot of ETFs that track the S&P 500. There are ETFs that track certain sectors of the stock market, like technology. There are even ETFs that track the performance of individual countries, like China. What about other asset classes? There are ETFs for all types of Fixed Income (bond) and money market (cash) investments. If you're looking for a fund that tracks the price of gold, $GLD is a common solution. Like I said, there's an ETF for almost everything.


Many investors like ETFs because they are easy to buy and sell (they trade just like stock). They also tend to give you instant diversification. If you own $SPY, you're exposed to the movement of ALL of the stocks in the S&P instead of just one.


While investing in individual stocks can provide you with handsome returns, it can also be very risky. ETFs spread that risk out among the hundreds, if not thousands, of underlying stocks/bonds/etc. that the fund exposes you to.


Another benefit provided by ETFs is the fact that most of them are cheap to own.


According to the WSJ: "The average ETF carries an expense ratio of 0.44%, which means the fund will cost you $4.40 in annual fees for every $1,000 you invest."


Why are ETFs cheaper than other types of investment funds, like mutual funds?


Most ETFs are considered PASSIVE INVESTMENTS. "Passive" means that the fund manager (investment company) is not actively picking different investments in order to attempt to provide you with a higher return. As we mentioned earlier, the ETF fund manager simply purchases the underlying type of investment(s) that it is attempting to track.


There is not a lot of decision-making being made by the fund manager. They just buy the specific investments. You're paying for convenience and exposure; not investment performance.


Professionally, the portfolios I ran for clients were ETF-heavy. I personally like the ability to access certain markets, sectors or industries while having diversification on my side.


Of course, ETFs are not free from risk. Any investment is subject to loss of principal. Also, past performance does not guarantee future results. Make sure you understand what you own, and all of the risks that are involved.


That being said, if you're looking for a way to get started with investing, ETFs can be a great way to start accumulating wealth. Almost all online brokerage solutions allow you to trade ETFs. There are also "robo-advisor" services that provide you with ETF portfolios.


As with anything related to your finances, do your research, and go with what's most suitable for your needs, preferences and goals.


Hope this helps. If you have any ETF-related questions, feel free to connect with me on IG: @themillennialmoneymentor.



-Jose













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© 2019 by Jose Hernandez