Why buy stocks instead of ETFs?
A single stock can potentially return a lot more than an ETF, where you receive the weighted average performance of the holdings. Stocks can pay dividends, and over time those dividends can rise, as the top companies increase their payouts. Companies can be acquired at a substantial premium to the current stock price.
Stock-picking offers an advantage over exchange-traded funds (ETFs) when there is a wide dispersion of returns from the mean. Exchange-traded funds (ETFs) offer advantages over stocks when the return from stocks in the sector has a narrow dispersion around the mean.
Higher Management Fees
Not all ETFs are passive. Some ETFs are actively managed, meaning they're managed by a fund manager whose goal is to outperform the market. Actively managed funds often have higher fees since they require management to guide the fund.
The single biggest risk in ETFs is market risk. Like a mutual fund or a closed-end fund, ETFs are only an investment vehicle—a wrapper for their underlying investment. So if you buy an S&P 500 ETF and the S&P 500 goes down 50%, nothing about how cheap, tax efficient, or transparent an ETF is will help you.
Key Takeaways. ETFs are less risky than individual stocks because they are diversified funds. Their investors also benefit from very low fees. Still, there are unique risks to some ETFs, including a lack of diversification and tax exposure.
Lower Dividend Yields
But if an investor can take on the risk, then owning individual stocks can mean much higher dividend yields. While you can pick the stock with the highest dividend yield, ETFs track a broader market, so the overall yield will average out to be lower.
Is Investing in the S&P 500 Less Risky Than Buying a Single Stock? Generally, yes. The S&P 500 is considered well-diversified by sector, which means it includes stocks in all major areas, including technology and consumer discretionary—meaning declines in some sectors may be offset by gains in other sectors.
ETFs may close due to lack of investor interest or poor returns. For investors, the easiest way to exit an ETF investment is to sell it on the open market. Liquidation of ETFs is strictly regulated; when an ETF closes, any remaining shareholders will receive a payout based on what they had invested in the ETF.
Typically, the issuer will give a minimum of 30 days' notice to allow investors to find an alternative ETF, or to alter their investment strategy. If you own ETF shares, you will receive cash equivalent to the value of your holding on the day of liquidation (not the value on the last day of trading).
Leveraged ETF prices tend to decay over time, and triple leverage will tend to decay at a faster rate than 2x leverage. As a result, they can tend toward zero.
Should I avoid ETFs?
ETFs are most often linked to a benchmarking index, meaning that they are often not designed to outperform that index. Investors looking for this type of outperformance (which also, of course, carries added risks) should perhaps look to other opportunities.
You expose your portfolio to much higher risk with sector ETFs, so you should use them sparingly, but investing 5% to 10% of your total portfolio assets may be appropriate. If you want to be highly conservative, don't use these at all.
Should you invest in ETFs? Since ETFs offer built-in diversification and don't require large amounts of capital in order to invest in a range of stocks, they are a good way to get started. You can trade them like stocks while also enjoying a diversified portfolio.
ETF | Assets under management | Expense ratio |
---|---|---|
Invesco QQQ Trust (ticker: QQQ) | $244 billion | 0.2% |
VanEck Semiconductor ETF (SMH) | $14 billion | 0.35% |
Consumer Discretionary Select Sector SPDR Fund (XLY) | $19 billion | 0.09% |
Global X Uranium ETF (URA) | $3 billion | 0.69% |
Too much diversification can dilute performance
Adding new ETFs to a portfolio that includes this Energy ETF would decrease its performance. Since the allocation to the Energy ETF will naturally decrease - and so will its contribution to the total portfolio return.
The securities that underlie the funds are held by a custodian, not by Vanguard. Vanguard is paid by the funds to provide administration and other services. If Vanguard ever did go bankrupt, the funds would not be affected and would simply hire another firm to provide these services.
Low minimum investments: ETFs typically have low minimum investment requirements, which is typically the price of one share. This allows beginners to start investing with relatively small amounts of capital.
Symbol | Name | 5-Year Return |
---|---|---|
PKB | Invesco Building & Construction ETF | 19.23% |
SCHG | Schwab U.S. Large-Cap Growth ETF | 18.96% |
QTEC | First Trust NASDAQ-100 Technology Sector Index Fund | 18.91% |
PAVE | Global X US Infrastructure Development ETF | 18.89% |
One of the ways that investors make money from exchange traded funds (ETFs) is through dividends that are paid to the ETF issuer and then paid on to their investors in proportion to the number of shares each holds.
According to our calculations, a $1000 investment made in February 2014 would be worth $5,971.20, or a gain of 497.12%, as of February 5, 2024, and this return excludes dividends but includes price increases. Compare this to the S&P 500's rally of 178.17% and gold's return of 55.50% over the same time frame.
How much would $10,000 invested in S&P 500?
Assuming an average annual return rate of about 10% (a typical historical average), a $10,000 investment in the S&P 500 could potentially grow to approximately $25,937 over 10 years.
Putting your money into S&P 500 ETFs only might limit your returns to some degree. But in exchange, you'll have a lot less work on your hands. You won't have to research individual stocks for your portfolio and keep tabs on their performance quarter after quarter.
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
ETFs. Investment funds are a strategic option during a recession because they have built-in diversification, minimizing volatility compared to individual stocks. However, the fees can get expensive for certain types of actively managed funds.
In order to withdraw from an exchange traded fund, you need to give your online broker or ETF platform an instruction to sell. ETFs offer guaranteed liquidity – you don't have to wait for a buyer or a seller.
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