Exchange-traded funds (ETFs) are low-cost investment funds that hold securities such as stocks and bonds. What makes ETFs unique is that they trade on exchanges just like stocks, with prices changing throughout the day. Some ETFs track a market index like index funds while others are actively managed like traditional mutual funds. Portfolio Solutions®, as index-based investment managers, uses only market-tracking ETFs, which is how we refer to them here.
HOW DO ETFS WORK?
ETFs operate in a similar fashion to index funds. They are made up of securities to resemble a particular index such as the S&P 500. But unlike mutual funds, which are priced at the end of each trading day based on their net asset value (NAV), ETFs trade throughout the day so their prices change as they are bought and sold.
The trade and price characteristics of ETFs give investors greater flexibility to buy and sell shares. However, investors should be mindful that they incur commissions from trading ETFs as they would from trading stocks and mutual funds.
WHY ETFS MAY BE RIGHT FOR YOUR PORTFOLIO?
The same advantages of index funds can also be provided by market-tracking ETFs. For one, they have low costs. In fact, their expense ratios are typically even lower than that of index funds. Additionally, ETFs offer broad diversification, which can help reduce a portfolio’s overall risk. Since ETFs are available in most asset classes, investors may have the choice between ETFs and index funds to get the market exposure they prefer in their portfolios.