Why are ETFs thought to be a safer bet than stocks?

Why are ETFs thought to be a safer bet than stocks?

Exchange-traded funds or ETFs are thought to be safer investments than stocks. But are they really so? Here we explore some reasons why this might be the case by diving into what ETFs are and why ETF trading may be superior to stock trading.

What are ETFs, and how do they work compared to stocks?

An ETF is an investment fund that trades on a stock exchange, much like stocks. However, an ETF invests in a basket of assets, such as stocks, bonds, or commodities. This diversification can help to reduce risk.

One key difference between ETFs and stocks is that humans do not actively manage ETFs; computer algorithms manage them. It means no emotional decision-making is involved in buying and selling assets within an ETF.

Another key difference is that you can trade ETFs throughout the day, whereas with stocks, you can only trade during specific market hours.

The benefits of ETFs over stocks

Why might ETFs be thought to be a safer investment than stocks?

Diversification-ETFs invest in a basket of assets rather than just one. This diversification helps to reduce the risk of one market suddenly poorly performing, which can lead to pretty drastic losses.

Low costs- ETFs typically have lower fees than actively-managed mutual funds.

Reduced emotional decision-making- As computer algorithms manage ETFs, no emotional decision-making is involved in buying and selling assets within an ETF. It can help avoid some mistakes investors make when they allow emotions to guide their investment decisions.

Tax efficiency- ETFs are generally more tax-efficient than stocks or mutual funds.

Access to hard-to-reach markets- Some ETFs offer access to markets that are otherwise difficult or impossible for individual investors to reach.

Flexibility- ETFs offer investors more flexibility than stocks or mutual funds. For example, investors can use stop-loss orders when investing in ETFs.

Liquidity- ETFs are generally more liquid than stocks or mutual funds, which means that they can be sold more efficiently and at a closing price to their actual value.

Why ETFs have become so popular in recent years

ETF trading has become increasingly popular in recent years for many reasons.

The financial crisis of 2008 led many investors to question the safety of stocks, and it increased interest in alternative and diversified investments, such as ETFs.

In recent years, there has been a growing movement toward index investing. It is where investors seek to track the performance of a particular market index, such as the S&P 500, rather than picking individual stocks. ETFs are often used to achieve this.

Robo-advisors are online investment services that use algorithms to manage investor portfolios. These services have grown in popularity in recent years, and many favours ETFs over other types of investment.

How to invest in ETFs for beginners

If you’re thinking of investing in ETFs, there are a few things you need to know first.

Choose an investment platform. You’ll need to open an account with an online broker or investment platform to invest in ETFs.

Decide what type of ETF you want to invest in. There is a wide variety of ETFs available, so choosing one that aligns with your investment goals is essential. Consider the costs. When choosing an ETF, consider the fees involved, which can eat into your investment returns if they’re not taken into account.

Start small and gradually increase your investment. When first investing in ETFs, it’s a good idea to start small and gradually increase your investment over time, and this will help you get comfortable with the process and minimize your risk.

The risks associated with investing in ETFs

While ETFs offer many advantages over stocks, there are also some risks to consider before investing in ETFs.

Market risk- Like all investments, ETFs are subject to market risk, which means that your investment’s value can go up or down depending on the overall performance of the markets.

Tracking error risk- Tracking error risk is the risk that an ETF will not track its target index as closely as intended. It can happen for many reasons, such as poor management or high fees.

Counterparty risk- It’s the risk that the other party in a financial transaction will not honour their obligations. It can be a problem with ETFs because they often use derivatives.

The bottom line

ETFs, offer many advantages over stocks, such as diversification, lower costs, and increased flexibility. However, there are also some risks to consider before investing in ETFs. Before investing in any security, it is essential to do your research and understand the risks and rewards.