Exchange traded funds -- ETFs -- are popular securities as both an investment or for active trading. ETFs take some of the features of mutual funds and some features of market traded securities and combine them, providing a unique class of investment products. The benefits or negatives for you as a young investor depend on your investment goals, techniques and experience.
Low Costs and Efficiency
Exchange traded funds have low expenses, which means very little of an investor's money goes to manage one of these funds. Each ETF will match the securities holdings of a specific stock or bond index or match the value changes of a particular commodity. An ETF provides an investor with a low-cost way to invest in a selected index. ETFs are also efficient because of the fact that shares trade on the exchanges. As the value of the tracked index changes, the share value of an ETF will immediately reflect the changes. The value of ETF shares will closely match changes in the overall market or selected sector. This is in contrast to individual stocks, which might move in one direction while the market or similar stocks move in the opposite direction.
Investing or Trading
Investors can use ETF shares for long-term investing, short-term trading or both. The low expenses and diverse offerings make ETFs good choices with which to build a long-term investment portfolio. An investor can build a portfolio with just a couple of funds or select funds from a wider range of market sectors. Because ETF shares trade on the stock exchanges and share values update continuously while the markets are open, the funds are also appropriate vehicles for short-term trading. ETFs can be used for day trading or longer term swing or trend trading. ETFs allow a trader to trade the market without the unpredictability of individual stocks.
Diverse and Unique Investment Choices
The wide range of available ETFs allow an investor to include investments in different asset classes in a single brokerage account. Besides stock funds covering broad market indexes and narrowly focused stock market sectors, ETFs are available to invest in bonds, international stocks and commodities such as gold, silver and crude oil. Other ETF choices allow a trader to generate profits when investment categories are declining in value. This is probably the biggest advantage of ETF investing -- the ability to select funds which can profit from gains or even down markets in every class and type of investment.
Cons of ETFs
Exchange traded funds are very useful investment securities. The negatives associated with ETFs fall into the category of inappropriate use. An investor with a long-term investment horizon and who wants to reinvest dividends is better served by mutual funds instead of ETFs. It is not possible to reinvest ETF dividends without paying broker commissions. Another potential negative of ETFs is how easy they are to trade. Investors can lose money in their brokerage accounts from over-trading and chasing hot funds. If ETFs are to be used for trading, the trader should have a detailed plan for buying and selling. Stock brokerage commissions apply to the purchase and sale of ETF shares. An investor who wants to invest small amounts of money will be better served by investing in a no-load mutual fund and not pay any commissions.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.