Why You Should Invest in ETFs
ETFs’ Brief History
In the world of investment, ETFs, or Exchange Traded Funds, are a fairly recent invention. The first known ETF was created in the late 1980s and first began trading in 1993. ETFs have experienced remarkable growth in the past 15 years, growing from about 100 funds in the early 2000s to over 1500 today.
Why You Should Invest in ETFs
- Flexibility / Liquidity – One key reasons why investors should build a portfolio using ETFs is because of its flexibility. As mentioned above, an ETF transaction can take place during a trading day like an individual stock. This is an important point when markets are volatile. Investors can use that volatility to lock in a favorable price by using limit buy or sell orders, which are not possible with a traditional mutual fund. ETFs allow for intraday investing.
- Diversification – Like a mutual fund, it offers diversification benefits but without the restrictions. With an ETF, investors get the best attributes of trading individual stocks and mutual funds.
- Wide Selection – ETFs invest in pretty much anything except for private assets. In additional to traditional assets like publicly traded equities and bonds, ETFs invest in currencies, real estate, and commodities. Using a site like ETF.com, you can get a glimpse of some of the possibilities. In addition to broad-market index-tracking funds, an ETF can be solely focused on a specific sector and geography. Take WisdomTree, for example, which offers ETFs that invest only in high yielding European equities or a Brazilian local currency strategy fund. Check out http://www.etf.com/etfanalytics/etf-finder.
- Leverage and Shorting – Some ETFs, like the popular PowerShares Ultra QQQ (QLD), seek double the return of the index it mirrors, which in the case of PowerShares Ultra QQQ, seeks to provide double the return of the Nasdaq 100. Using inverse ETFs, one can short the market without facing the risks of shorting an individual equity. With an inverse ETF, an investor seeks the earn returns that are inversely proportional of a particular index. For example, the Short S&P 500 (SH) seeks to earn returns on the S&P 500 when it declines.
- Lower Costs – Unlike some funds that have minimum amounts and / or sales loads (upfront or backend fees), ETFs do not have such fees. Also, the management / administrative fees of many ETFs are quite low, similar to the best of index mutual funds.
Check out this ETF 101 video:
Well-Known ETF Families
Perhaps the most well-known ETF family is the Blackrock iShares family, which is one of the first “mega” ETF families. In recent years, mutual fund giants like Fidelity, Vanguard, and PIMCO have launched their own ETFs, which in many cases, are similar to their most popular mutual fund products but with the attractive qualities that ETFs offer (as mentioned above). Other large well-known ETF families include State Street, Powershares, ProShares, and WisdomTree, to name a few. For a full list of ETF families, please refer to some of the resources offered below.
Billionaire Hedge Fund Managers Use ETFs
If you think ETFs are only for small time day traders, then think again. Many well-known highly successful hedge fund managers use ETFs for their trading strategies. They like them for many of the same reasons mentioned above. Ray Dalio, who heads up Bridgewater Associates, the largest hedge fund in the fund, use the Vanguard Emerging Markets (VWO), SPDR S&P 500 (SPY), and iShares MSCI Emerging Markets (EEM). These ETFs offer Dalio and his multi-billion dollar fund to trade in different market conditions.
Ways to Use ETFs
Given the numerous sectors, asset classes, and geographies that ETFs, there are numerous ways to construct a short or long-term portfolio. Back in 2007-08, traders who suspected a big downturn could have used broad market inverse ETFs to short the market. For those with high conviction of a collapse in the financial sector could have bought the UltraShort Financials ETF (SKF), which offers 2x leverage or the Direxion Daily Financial Bear 3x to get triple the leverage. As the financial sector collapsed due to the bankruptcy of Lehman Brothers and numerous other banks took hold, these inverse ETFs protected portfolios and even helped traders gain profits as the rest of the markets suffered huge losses.
Additional Resources on ETFs: