WHAT IS AN ETF (EXCHANGE-TRADED FUND)?

Understanding the potential benefits of ETFs is an important step toward determining whether ETFs can be an appropriate choice for your portfolio.

Access

Providing investors a simpler, more efficient way to access the financial markets has likely helped ETFs grow in popularity – and assets under management — since the first ETFs launched in the early 1990s. Today, millions of people around the world use ETFs to access the financial markets in the same way as the largest institutional investors — with the click of a button, for a known price.

The technology of ETFs has empowered investors of all types to easily and conveniently access both broad market exposures, as well as more-targeted investments in previously hard-to-reach markets.

Within a single security, ETFs can offer access to entire markets and asset classes, such as stocks and bonds, commodities and digital assets, as well as specific exposures to sectors like information technology, various countries and regions, or different types of bonds.

Low cost

Whether it’s at the grocery store, the mall or the gas station, a penny saved truly is a penny earned. The same is true when it comes to your investments, where keeping costs low can help you reach your goals sooner. Even small fees can have a big impact on your portfolio because not only is your balance reduced by the fee, you also lose any return you would have earned on the money used to pay the fee.

ETFs are widely available commission free on most online brokerage accounts and through investment professionals. You can also purchase directly through platforms like Fidelity, where iShares ETFs trade commission-free online.

In addition, there’s no investment minimum with iShares ETFs… and you can start with as little as $1 when you buy fractional shares of iShares ETFs.

When it comes to owning ETFs, a key element to consider is the Total Expense Ratio (TER), which represents the total cost of holding an ETF for one year. These costs consist primarily of management fees and additional fund expenses, such as trading fees, legal fees, auditor fees, and other operational expenses.

Diversification

The primary goal of investing is typically to generate the highest possible return for the lowest risk. Diversification might be able to help you obtain this balance. By spreading investments across asset classes, geographies and sectors, investors may lower their risks as the poor performance of one investment could be offset by stronger performance in another, and vice versa.

Index ETFs generally seek to track indexes that are comprised of many individual securities, helping to spread the risk and reduce the impact of price swings in any one security. Although this does not eliminate risk entirely, the diversified structure of ETFs has the potential to improve the risk-adjusted return of your portfolio.

Liquidity

The deep liquidity of ETFs — the speed with which they can be bought and sold — comes from the markets on which they are traded. ETFs trade on exchanges and investors can buy or sell throughout the trading day, just like stocks.

And just like stocks, you can buy and sell ETFs in a variety of ways:

• Market orders execute as soon as possible at the best price available at the time. Market orders are best used when it’s more important to make sure the trade gets executed vs. the specific price.
• Limit or stop-limit orders mitigate the impact of intraday price swings by giving you more control over the price to buy or sell. Limit orders are particularly helpful in volatile markets but can expire if your price target isn’t met, meaning there’s no guarantee the trade will get done.
• Stop loss orders are triggered when the price of a security falls below a specific level. Stop orders can help protect your gains and limit your losses but trades may be delayed, especially in times of market stress.

The ease of trading ETFs gives investors more control over when and how they trade. This liquidity feature is one of the key benefits of owning ETFs, particularly when compared to mutual funds. Just make sure your order type is consistent with your goals.

Tax efficiency

You’ve probably learned that keeping fees low is a big driver of successful investing. And while that's important, taxes may be more detrimental to long-term returns than fund management fees.

ETFs can help shield investors from capital gains taxes.

A big reason for the tax efficiency of ETFs is the vast majority are index funds, which typically trade less frequently than actively managed funds. Low turnover means fewer sales of stocks that have appreciated, generating fewer taxable capital gains.

In addition, investors buy and sell ETF shares with other investors on an exchange. As a result, the ETF manager doesn't have to sell holdings — potentially creating capital gains — to meet investor redemptions. Mutual fund shareholders, on the other hand, redeem shares directly from the fund. The fund manager must often sell fund securities to honor redemptions, potentially triggering capital gains which then trickle down to all investors in the fund.

Certain traditional mutual funds can be tax efficient and, of course, ETF shareholders can incur tax consequences when they sell shares on the exchange, but that tax consequence is not passed on to other ETF shareholders.

For investments in so-called qualified accounts like a 401(k) or IRA, taxes are a less-immediate consideration. But for investors with taxable (non-qualified) accounts, owning cost- and tax-efficient iShares ETFs can help improve your long-term investment returns, allowing you to keep more of what you earn.

Transparency

Knowing exactly what you own is important information you need when making financial decisions. ETFs aim to be straightforward and transparent about their investment objectives. In addition, information on ETFs holdings, performance and costs is published daily and freely available on the product page for each ETF.

While ETFs disclose holdings daily, that typically happens monthly or quarterly with mutual funds. Because of their longer disclosure cycle and the greater leeway that active fund managers have when choosing investments, some mutual funds have historically been affected by what’s known as “style drift.” Style drift occurs when a fund’s holdings change over time and sometimes stray farther from the fund’s intended strategy than investors may realize.

With ETFs, you’ll always be able to know what you own and don’t have to worry about style drift.