In a previous post, I wrote about David Swensen and his model for creating a diversified portfolio. A key point is selecting ETFs that align with the parameters of his model. In this article, I want to quickly explain what an ETF is and why it might be the best option for investors with little experience.
An ETF (Exchange-Traded Fund) is an investment fund that trades on the stock exchange, meaning you can buy and sell shares of this fund just like you would with an individual stock. Unlike single-company stocks, an ETF bundles several assets, such as stocks, bonds, or commodities, into one package, making diversification easier.
How is an ETF composed?
ETFs are usually composed of a selection of assets that follow a specific index, such as the S&P 500 or the Nasdaq 100. This allows investors to gain exposure to a wide range of assets without needing to buy each one individually. There are also ETFs that focus on specific sectors (technology, finance, healthcare, etc.) or commodities like gold or oil.
Diversification and benefits
One of the main benefits of ETFs is diversification. By investing in an ETF, you’re not putting all your money into a single stock or sector but spreading it across multiple assets. This reduces risk, as losses in one asset can be offset by gains in another.
Additionally, ETFs are known for being low-cost, as most are passively managed. This means they simply track an index rather than being actively managed by a team of experts, which lowers fees and commissions.
Associated risks
While ETFs are less risky than investing in individual stocks, they are not risk-free. The value of an ETF can decrease if the assets it holds lose value. Moreover, some more complex ETFs, such as leveraged ETFs or those that focus on very specific sectors, can be volatile and risky for inexperienced investors.
Examples of popular ETFs
Some of the best-known ETFs include the SPDR S&P 500 ETF (SPY), which tracks the S&P 500 index, and the Vanguard Total Stock Market ETF (VTI), which offers access to the entire U.S. stock market, including about 3,500 companies listed on the NYSE.
Another popular ETF is the Vanguard S&P 500 ETF (VOO), which also tracks the S&P 500 index, representing the top 500 companies in the U.S. All of these ETFs allow investors to diversify into large portions of the market with just one click.
In summary, ETFs are an attractive option for both beginner and experienced investors looking to diversify their investments simply and at low cost. However, it’s always important to understand the associated risks before making any investment decisions.