Trading ETFs has become an extremely popular trend among investors across the globe – especially within the past few years. While some investors believe that these funds will continue to grow in popularity, others claim that due to their surge in popularity, ETFs have become so large that they may be heading toward an inevitable downfall. The question for you is – what do you think? In order for you to make your own decision about ETFs, we’re here to lay out some of the basic facts.
First, let’s start by breaking down ETFs as an asset class. ETFs, or exchange-traded funds, are securities that track various stocks, commodities, or bonds. These funds are unique because they act as maps for groups of different assets, but they trade individually, similar to common stocks on a stock exchange. Because one ETF can be bought and sold in the same way as a stock can be bought and sold, investors typically view ETFs as a more liquid asset class. Further, many people view ETFs as a more volatile option, as compared to other fund-structured investments like mutual funds.
Of the investors who have really gotten behind ETFs recently, many find ETFs to be attractive investment options because of their value towards the diversification of their portfolios. Essentially, because ETFs are funds that own shares of their underlying assets (whether it be a variety of stocks, bonds, currencies, or another type of asset), buying a share of an ETF is similar to buying fractional shares of many other assets at once. The price of the share you buy is a reflection of the prices of the many assets that comprise it. The only difference is that shareholders do not pick and choose which assets make up their ETF shares. Instead, that structure is determined by the fund itself, with investors having indirect ownership of their assets. Similarly, ETFs also give their shareholders the equal proportion of revenues or dividends earned by the assets they are holding.
Another big reason that investors find ETFs to be so attractive is because the ease of buying and selling shares of various ETFs. Unlike buying shares in a mutual fund, investors simply pay the same commission to their brokers that they would pay on any regular stock purchase. Further, many widely-traded ETFs are traded on stock exchanges and can be traded in exactly the same way as investors would normally trade stock shares.
For these reasons, among others, ETFs have become extremely successful investment vehicles since their inception in 1993. Additionally, they have become the place for many investors to start investing, because they provide a simple means for diversification both within and between asset classes.
However, as previously mentioned, some analysts are beginning to claim that the popularity of ETFs could be “a ticking time bomb.” For example, see this article recently posted on MarketWatch. These analysts believe that the immense growth in the attractiveness of ETFs could create a situation in which their underlying stocks become extremely illiquid. This is likely due to the fact that investors tend to hold ETFs for longer periods than they typically hold single stocks. Further, some analysts have referenced scenarios in which a single stock has become mispriced as a result of an ETF’s growth that ultimately misrepresented the value of that single stock. Finally, some investors argue that these could be fundamental issues with the structure of ETFs that may eventually create a negative market reaction and thereby diminish the current popularity of many ETFs.
Of course, this matter is yours to evaluate independently. Do you think that ETFs are something you might like to include in your portfolio? Or, do you think that these investments may be more trouble than they’re worth? As always, it is best to read up on the topic and on other investors’ opinions before making your decision!