- ETFs offer diversification and tax benefits with a low barrier to entry for new investors.
- Risk management expert Tony Dong explains how ETFs can benefit an investment portfolio.
- He also mentions two specific ETFs that novice investors would do well to consider.
To prepare for a comfortable financial future, investing is vital for most people. However, with the economy struggling under the weight of high inflation and rising interest rates — along with the threat of an impending recession — there can be uncertainty about the best safeguards to protect a nest egg during a downturn.
In other words, what are the best investments to make right now and if someone is just starting to invest, what should they look out for?
Insider spoke with Tony Dong, a risk management professional specializing in portfolio management, factor investing and asset allocation to discuss how and why ETFs should become part of your investment portfolio. Dong holds the Canadian Securities Institute’s Fundamental Securities Trading Credential.
When deciding on your investment goals—funding your retirement, providing another source of income, or building wealth over time—realize that there are many ways to invest and many options for investing. However, there are several important factors to consider, such as risk tolerance, time horizon, financial goals and how much you can afford to invest.
If you’re just getting started with investing or have a shorter time horizon, you may want to invest in low-risk investments that offer diversification, Dong tells Insider.
“There’s a reason why ETFs have grown in popularity. They offer diversification, they’re easy to invest in, which means new investors can choose, and they’re a cost-effective approach to investing,” Dong explains.
Investors added the most amount ever to ETFs during 2020, at $507.4 billion over the course of the year, and ETFs continue to grow. Dong explains why Exchange Traded Funds or ETFs are a safe entry point to invest more and diversify your portfolio, and offers some of his top picks for the best ETFs to start investing.
What is an Exchange Traded Fund (ETF)?
Exchange Traded Funds, better known as ETFs, are an investment vehicle that holds a variety of securities that can be easily purchased through brokerage firms and are similar to a mutual fund index. An ETF can hold hundreds of stocks, and when you buy an ETF, you become a partial owner of the fund.
“When you buy an ETF, you have access to every stock it owns, which means you don’t have to buy the stock individually,” Dong explains of the lower-risk nature of this security.
ETFs offer diversification, low expenses and flexibility that can suit many financial goals and can be suitable for both novice and expert investors.
They have many advantages over traditional funds. The 4 most common advantages are: trading flexibility, diversification, risk management and tax benefits.
ETFs are flexible investment vehicles that are highly liquid and can be bought and sold like individual stocks. Since they can be traded like stocks, it is possible to invest in ETFs with a brokerage account, which makes them more accessible to many investors.
“The trading flexibility of ETFs can make them ideal for investors, even if they are just starting out. They offer entry-level access, you can buy just one share, so it’s a great way to get started,” says Dong on this matter.
ETFs can be very flexible, allowing an investor to move money between stocks, bonds or commodities. ETFs also trade like stocks, so you can see current prices and decide how much you can afford to buy on any given trade.
ETFs offer investors the ability to diversify their portfolio in ways that other investment vehicles do not. They now trade in almost every asset class, commodity and currency. Investing in ETFs allows the investor to have multiple holdings by buying stocks and bonds, which can be done through a single ETF.
“This can be great for investors who don’t know the stock market well, ETFs are an effective way to diversify your portfolio without having to pick individual stocks or bonds. A properly diversified portfolio is key to investment success” , says Dong.
ETFs are often designed to provide immediate diversification. This allows investors to invest on a fixed basis in any stock or currency without taking the risk or exposure associated with investing in any stock. Diversification can help protect your portfolio from market volatility.
In general, ETFs significantly reduce investment risk. ETFs give investors easy access to asset classes and markets that were previously difficult or expensive to invest in. Additionally, ETFs were more likely to survive market crashes. There will always be volatility in the stock market, but S&P 500 ETFs are more likely to recover over time.
“There are some ETFs that come with built-in protection against risk, such as the Nationwide Risk Managed Income ETF and the Simplify US Equity Plus Downside Convexity ETF, which uses put options on the S&P 500 to hedge against a downturn,” Dong explains.
For investors who are perhaps more risk averse, ETFs are an investment option, not only do they reduce risk, but they usually report their holdings on a daily basis, this allows the investor to know the full details of their investment and can alert an investor to risks.
If you invest in a mutual fund, you may have to pay capital gains taxes during your investment. ETFs incur capital gains taxes only when you sell the investment, meaning you’ll pay less tax on your investment overall.
“Because of their structure, ETFs generally have lower turnover and therefore less capital gains compared to mutual funds, so investors pay less tax on distributions,” says Dong.
ETFs can play an important role in an investment portfolio. They can allow you to invest based on your risk tolerance, niche investments and market sectors.