What Is An ETF? And Building Your Investment Portfolio

Investing

4 Min Read

illustration of trading screen emphasizing the word ETF surrounded by tickers

Investing can be a great way to grow your wealth and create more opportunities for yourself. However, successful investing includes smart strategy and knowledge. While you can simply try something and see how it goes, carefully crafting your portfolio with certain assets and funds could be better in the long run. 

Once you learn how to start investing, and as you build your investment portfolio, consider using ETFs in your strategy to help you diversify your portfolio.

And here’s your disclaimer: We are by no means providing financial advice. We’re just providing a starting point for you to research further.

What is an ETF?

ETF is short for exchange-traded fund and is a popular way to invest. ETFs are designed to function like index holdings while allowing investors to make a single transaction. Having an ETF share is essentially like having a mini index portfolio. Therefore, it's a simple way of diversifying and enjoying the benefits of an index in a user-friendly way.

How Do ETFs Benefit a Balanced Investment Portfolio?

ETFs have several benefits for investors that make them a valuable investment. On the surface level, having ETFs can help you hedge your risk by diversifying your portfolio, as well as exposing you to new markets.

Single Transactions

As mentioned earlier, you can buy a share of an ETF in a single transaction. This allows you to have the power of an index without the process of one. When you invest in an index, you usually have to purchase each security in that index individually. ETFs on the other hand give you exposure to a similar range of securities more easily.

Stock-Like Functionality

Simple doesn't have to mean sacrifice. If you buy ETFs, you can still invest with the same flexibility of stocks. Both are traded through market hours, meaning you can buy in or cash out with ease, making it easy to adjust your investment strategy as you see fit. You can sell ETFs just like you can equities, which makes them a popular choice for many investors.

Also, if you enjoy using options, swaps, and futures contracts, you can do this with many ETFs. A little research into the ETFs you invest in can help you find one that gives you the flexibility to use your favorite investing strategies.

Cost-Effective

Compared to mutual funds or a basket of goods, ETFs can be low-fee. Since you're only completing a single transaction, you're already reducing the fees you would incur if buying all the securities in an index. On top of that, management fees tend to be lower on ETFs than on mutual funds.

ETFs have even been called "tax-friendly." Any capital gains taxes on your ETF are not charged until you sell the asset. Meaning, you have the freedom to incur those taxes when you choose. Compare this to mutual funds, which are typically charged on an annual basis.

How Do You Choose an ETF?

When choosing an ETF, it's wise to compare your current portfolio to the ETFs you're considering. Factors such as risk exposure, asset class, and investment sector can make a huge difference. A good goal is to use ETFs to hedge risk and diversify your portfolio, so the ETF you choose should check those boxes.

Another way to choose a good ETF for your portfolio is to consider any gaps in your investments. Choosing something that fills those gaps can help to diversify your holdings. If you have a lot of domestic holdings, choosing an ETF that has more international holdings can help to balance you out. You could also think about including various market caps in your portfolio and choosing an ETF that can help with that.

What Are Good ETF Investment Strategies?

A popular portfolio structure involving ETFs is called the core-satellite strategy. Essentially, you choose a core of solid, diversified ETFs for stability, combined with a satellite of heavy-hitting investments chosen for growth. The satellite investments are return-driven, while the diversification of the ETFs help to mitigate those risk and keep the whole portfolio balanced.

If you're a newer investor, dollar-cost averaging can be a good strategy to dip your toes in. With this strategy, you choose a designated amount of money to invest regularly into ETF shares. Often, you choose an ETF and invest in it consistently. This strategy is designed to build consistency and mitigate risk. By investing at regular intervals, you can buy ETF shares when the market is down, as well as up, which over time, can drive up your overall return. Doing this with ETFs is often more effective than doing so with a single stock pick.

How Do You Purchase an ETF?

There are typically two ways to buy into an ETF—through a limit order, or a market order. A limit order is when you, the investor, choose your preferred price for a share. If you choose this route, it can take some waiting before you're able to buy in. But the payoff is that you can potentially get what you want at the price you want it.

If you're not as patient, you can choose to buy a market order. This simply refers to the market price of an ETF, so you're paying the immediate face value. If you go this route, that could mean you're buying in at a higher price. However, you can bypass the waiting this way—especially if you think something is about to take off.

Diversify with ETFs

ETFs are a great way to get into investing with a diversified portfolio and begin your journey to your money goal. You benefit from a single transaction and fewer fees, with access to a fund as opposed to a single stock. As an individual investor, this can be a game-changer.

While stocks and ETFs can help you in the long-run, see how an app like Monorail can help you make other solid financial moves in your day-to-day.

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