Exchange-traded funds, or ETFs, are a type of investment that allow you to purchase baskets of stocks containing shares of hundreds, if not thousands, of companies with a single purchase. You’re pretty much getting the entire stock market when you invest in them.
ETFs are usually low-cost and help provide instant diversification to your portfolio, meaning your money is spread out among hundreds of companies, instead of just one. This protects your investments. Because of this, ETFs are a great choice for beginner investors.
You might hear ETFs referred to interchangeably as index funds, and that’s because most ETFs are a popular type of index fund.
Let’s talk about how safe ETFs are as long-term investments, and how they compare to other investment options.
Pros of ETFs
When you invest in ETFs, you are getting more bang for your buck, says Kacie Swartz, certified financial planner at Stone Wealth Management. “The first pro is that it’s a terrific entry level into investing. You’re going to get a diversified pool of securities, all inside that ETF wrapper.”
One of the most important features of an ETF is its diversification. “Without a doubt, not having all your eggs in one basket is huge,” says Ariel Acuña, president at LTG Capital. The second most important feature is that ETFs are highly tax-efficient. They also have a low cost to trade and historically have strong returns. ETFs are traded like stocks so you can buy and sell when the market is open.
Because they’re highly diversified, ETFs are generally considered safe long-term investments with historically dependable returns. Experts recommend a low-cost ETF that tracks a large chunk of the market.
Swartz points out that another big advantage with ETFs is that you don’t have to choose which company stocks you want to buy. Instead, once you select an ETF, you’re invested in multiple companies all at once, eliminating analysis paralysis and decision fatigue, which can hinder you from getting started in the market.
With ETFs, all your investments are chosen and handled for you, and the barrier to entry is extremely low. Even if you don’t have a lot to start with, many of the best online brokers allow you to start an account and invest with small amounts. Considering that some of the top individual stocks can cost hundreds of dollars each, like Amazon and Google, ETFs open the door for many investors to get a piece of those stocks, but without the high price tag.
Risks With ETFs
ETFs seek to match their underlying index, such as the S&P 500 or Russell 2000. The indexes themselves are academic concepts and ETFs are simply vehicles that allow you access to all the companies within a fund. That said, it’s important for you to understand exactly what you’re investing in. In general, a broad-market fund is a safe bet.
That’s not to say there aren’t any risks. Any investment in the stock market can come with some downsides. But if you do your research, you can eliminate many of those mistakes. You’ll want to make sure the expense ratios, or fees, for the ETF are low. Experts recommend anything under .2% is a good fee, and anything higher than 1% is detrimental, and can eat into your profits.
The biggest risk is if the overall market dips, so will your portfolio. But the diversification should be enough to safeguard your money, especially if you’re investing long-term, such as for retirement. Don’t forget, when you invest in the stock market, you are playing a long term game. Don’t worry about downturns in the market — those are normal. Look at the future and keep your money invested.
Are ETFs Safer Than Stocks?
There are risks with any investments, but your risks with ETFs are limited compared to individual stock investing. That’s because when a company you’re only invested in goes bankrupt, you also lose everything. This is why diversification across your portfolio is so important.
But when you’re invested in hundreds of companies through an ETF, “your chances of going to zero with your investments is almost impossible,” says Swartz. It’s hard to recreate that diversification when you’re choosing individual stocks.
Are ETFs Safe in a Market Crash?
For the most part, yes. If there are big dips or corrections, your funds will also go down. But “there’s never been an instance where a broadly diversified ETF has gone down and not gone up to higher highs later,” says Acuña.
If you have a long investment horizon, market crashes are actually an amazing wealth building opportunity because you get to buy ETFs at a discount. Know that there will be market dips and crashes, and controlling your emotions when the market falls is just a part of being a long-term investor. Don’t sell, if you can. If you can accept it will happen at some point, you’ll know you can withstand them when they happen.
And when an ETF is diversified, it’s unlikely that at least some of the companies won’t hold their weight in a crash. There are many companies, such as AT&T, Chevron, and Target, known as Dividend Aristocrats and Dividend Kings that have proven to be reliably safe bets year after year, despite what the overall market does. As long as your ETF holds some of these companies, you’ll likely have the resilience to get through a temporary dip.