Exchange Traded Funds (ETFs) are a great way to diversify your investment portfolio without adding lots of risk to your current portfolio. ETFs are a useful tool for beginners, or even seasoned experts, for portfolio diversification for a few key reasons. First, ETFs are similar to managed funds in that an investment professional has pre-selected a set of stocks, bonds, and/or other types of funds and ETFs, but with one great advantage – ETFs can be purchased in incremental amounts in exactly the same way stocks are bought and sold! This means “getting into” an ETF requires much less start-up cash, than say, getting into a Mutual Fund (which can typically only be purchased in increments of $5,000 or more). Second, the fees associated with ETFs are much lower than Mutual Funds or other fund types, and typically range from 0.20% to 0.50% per annually. Third, since ETFs are more liquid than Mutual Funds, but slightly less liquid than stocks (fees may apply for holding an ETF less than 30 days for some brokers), they offer an intermediate ground for investors seeking a mixture of growth and financial security.
Let’s discuss a particular ETF to elucidate why these types of funds are such a great way to diversify your investment portfolio. Let’s look at the Vanguard Total Stock Market Index Fund ETF (Stock ticker: VTI). Currently shares of this stock (VTI) can be purchased for $116.77 (as of 12/18/2016). VTI is a large cap blend stock, which means that it has a diversified blend of large capital stocks already built into its portfolio, which has a current market value of $488 billion dollars. It’s always a good idea to only invest in ETFs that have a minimum market capital value of $1 billion or more – this ensures that the fund will not be disappearing anytime soon! Importantly, we will note that VTI pays a 2.40% annual dividend, which is payed out in four quarterly allotments. When looking at ETFs, try to only purchase ones that will meet or beat the average U.S. inflation rate of 2% – VTI does this. Taking a closer look at VTI’s portfolio, we will see that it is truly made up of a diverse array of stocks and funds. For example, we can see that VTI’s portfolio includes stocks and funds in industries such as basic materials (e.g., aluminum, copper, steel), real estate, financial services, consumer defensive (e.g., food products), communication services, energy, and technology – just to name a few! The important lesson here, is that VTI is protected from major changes in the stock market by being diversified, and yet has enough growth funds that it will produce a reliable dividend and grow in value over the years.
The examples and key points I’ve outlined here are all great reasons to look into ETFs as a way to diversify your investment portfolio. I hope you’ve learned some of the basics of investing in ETFs, and why they are important to creating and managing a diverse portfolio. Remember that maintaining a diverse investment portfolio will not only protect your assets from major changes, losses, or downturns in the stock market, but also position your portfolio to take advantage of times of growth across multiple financial sectors. Good luck and always remember to do plenty of research before investing in any type of fund (stock or ETF).
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