It’s no secret in the financial services industry - exchange traded funds, or ETFs, should be at the heart of your investment strategy.
More often than not, it is one of the most effective investment vehicles to build your wealth.
This is especially true when you have your money in different accounts spread out across a variety of institutions and types of investments. We see this frequently with our clients, and our remapping and consolidation strategies utilize ETFs a majority of the time.
Why?
The Big 3: Diversification, Cost, and Liquidity.
Exchange traded funds not only allow you to diversify your portfolio, providing opportunities for reducing risk and offering greater gain potential, they typically cost you less, and since they trade real-time like a stock - you have more flexibility if access to cash is needed.
What exactly is an Exchange Traded Fund (ETF)?
Before we dive into the Big 3 of ETFs, let’s take a quick step back and make sure we are clear on the definition.
An exchange traded fund is a “basket” or collection of stocks that track some asset: like an index, sector, or commodity. While often structured to track pricing of a large collection of securities related to a central theme, sector, or underlying strategy, ETFs can also track the price of an individual commodity. They can also be bought or sold on the stock exchange just like a regular stock.
Exchange traded funds can be focused on one particular industry or “sector,” or they can track many stocks across different industries or sectors. They can invest specifically in commodities, or they can track domestic and foreign currencies. They can even be set up to track stock declines and hope to earn gains by shorting stocks.
For examples of popular ETFs, check out Investopedia’s “Real-World Examples of ETF” section here.
The flexibility in structure is part of the beauty of an exchange traded fund. With ETFs, we can build a collection of investments that aligns with your customized investment strategy and goals, all without sacrificing access to cash or dealing with high transaction fees. As fiduciary advisors, firms like MA Private Wealth are obligated to work through the complexity of the various options and develop a diversified approach that is in your best interest.
Let’s dig into the Big 3 of ETFs: Diversification, Cost, and Liquidity.
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1. ETFs Provide Portfolio Diversification, Offering Both Upside Potential and Reduced Concentration Risk
We touched on this a bit above when we discussed an exchange traded funds’ structural capabilities.
ETFs often track a large collection of stocks, hundreds or thousands of stocks that are spread out across companies within a specific sector or industry, or diversified across a wide variety of industries and sectors. Instead of putting all your eggs in one basket, an ETF is an investment vehicle that can build your wealth by spreading it out across a wide span of different avenues.
Why is diversifying your portfolio so important?
First, it offers you greater upside potential across the board. In not doubling down on a particular company or even industry, your investments can benefit from growth that happens across the landscape. Perhaps your structured exchange traded fund includes both domestic and foreign securities, and the foreign exchange market experiences growth that surpasses what is happening in U.S. markets. Your diversified portfolio, through the ETF as your investment vehicle of choice, will benefit from those gains.
Second, in a similar way, the more diversified your investments, the greater the reduction in concentration risk. When your wealth is spread out amongst various sectors, industries, and companies, your portfolio is less prone to dramatic declines or loss in value when market events occur. If you concentrate all of your wealth into a specific company or stock or sometimes even one industry, your investments can be at a higher risk for greater volatility, at the mercy of the individual stock or industry’s performance.
Spreading out and diversifying your investments is a strategy that can give your portfolio more opportunities to grow while also lowering risk by distributing it across a wider spectrum of platforms.
2. ETFs Typically Have A Lower Internal Cost Structure than Other Investment Vehicles
One of the key reasons fiduciary advisors like MA Private Wealth utilize exchange traded funds is that it ends up saving clients money with lower expense ratios.
An “expense ratio” is calculated by taking a fund’s operating expenses and dividing it by the average dollar value of its assets under management (AUM).
Since fiduciaries are obligated to act in each client’s best interest, this should be part of the overall approach to building an investment strategy. While the focus is on maximizing growth opportunities, reducing risk, and providing flexibility, considering embedded client expenses and fees is an important part of the process.
Here in this example we see one of the great benefits of working with a fiduciary advisor. In not being beholden to a specific fund or company, they can design portfolios completely focused on what is best for the client, choosing from the entire universe of investment options.
Generally speaking, exchange traded funds have lower expense ratios for clients. Whereas mutual fund internal expenses have average annual expenses of greater than 1%, ETF internal expenses average 0.5%, but can be as low as 0.06%. ETFs do not have upfront or backend sales charges like most mutual funds. Depending on the amount of assets being invested, the difference in transaction fees and other charges can be significant and should factor into the overall strategy.
It can be complex to synthesize the costs of embedded fees versus the growth potential of different investment vehicles. Fiduciary advisors can simplify things by researching all of the associated costs and helping you build a strategy that puts you in the best possible position to grow your wealth.
Pro Tip:
Do you know what you’re actually paying for your 401k? We’re talking about the embedded or internal investment fees, not about the amount of money you are investing each year. It may be worth taking a look.
3. ETFs Offer Flexibility in their Liquidity
In finance terms, the “liquidity” of an investment is a reference to how quickly it can be accessed as cash.
There is a spectrum of liquidity tied to various investment vehicles, and with some investments such as private equity, structured products and annuities, as a few examples, it can be difficult for clients to access funds when needed.
Since exchange traded funds trade like a stock and the trade executes real-time, they are a truly “liquid” investment vehicle. We see our clients get access to cash within 2 business days most of the time if needed.
The flexibility here is key. Everyone wants and needs access to cash. It is seen as the “most liquid” asset, and advisors work with clients to determine an appropriate level of cash reserves to fit their specific needs. The problem is cash typically only earns a 0.01% return while it sits at the bank. Using ETFs as an investment vehicle can provide nearly the same flexibility as cash reserves, but actually allow for growth efforts in the market.
It’s also worth mentioning that without high upfront or backend sales charges (as described in #2 above), investors are typically more able and willing to take advantage of the liquidity.
This liquidity offers clients much more flexibility than those investments tied down by contractual obligations, and allows us to be more nimble in our investment approach.
It’s time to position exchange traded funds at the forefront of your investment strategy
Exchange traded funds (ETFs) offer diversification, lower costs, and flexibility in their liquidity, and they can be structured to align with your overall investment plan.
If you have money spread out across a variety of institutions and investments, it may be time to consolidate and strategically remap your assets using ETFs as your primary investment vehicle.
Unsure about where to start? Partnering with a fiduciary financial advisor like MA Private Wealth can simplify the complex in wealth management and gives you the assurance that someone is obligated to look out for your best interests.
You can set up a complimentary consultation to learn how our team of advisors can help you at the link below.
