Everyone knows the old saying about putting all of your eggs in one basket. It’s a dangerous strategy because if something happens to that basket, you will have nothing left. The same goes for investing—putting all of your funds into a single asset can be dangerous as your ability to make or lose money relies solely on the performance of that one asset. Diversification is a powerful investment tool that would allow you to invest across multiple assets to yield positive return with low risk.
What Is Diversification?
The solution, both in eggs and investing, is . That means developing a portfolio that contains a mix of assets and geographical locations—for example, an assortment of stocks, bonds and cash equivalents based in different countries. Ideally, your selections work together in harmony, so if one goes down, another goes up. This strategy can keep your portfolio reasonably stable.
The trouble with building a diversified portfolio independently is that it takes a lot of time to research individual securities and select options that complement each other. You would then have to monitor each asset in your portfolio on a regular basis to ensure you maintain the balance you worked so hard to create.
Diversification Made Simple
The original solution to this challenge was introduced in 1924 with mutual funds. Mutual fund managers do the research and maintenance for you and each mutual fund share represents a diversified mix of assets. However, mutual funds are not without their disadvantages. For example, mutual fund expenses tend to be high.
In the 1990s, a new product came to market: exchange-traded funds, also known as ETFs. These gave shareholders the advantages associated with mutual funds, along with additional benefits that investors find very appealing.
What Are ETFs?
Like mutual funds, ETF providers put together a basket of assets with pooled funds from shareholders. However, unlike mutual funds, ETFs are designed to mirror an underlying index. For example, there are ETFs tied to all major indexes, including the Dow Jones Industrial Average, the Nasdaq 100 or the S&P 500.
ETFs can also be designed to replicate returns on niche indexes and themes. There are ETFs focused on blue-chip stocks, social issues, commodities, technology, cryptocurrency and the environment, to name a few. Regardless of the underlying index, niche or theme, each share offers investors exposure to the entire portfolio. That means instant diversification without excessive research.
Benefits of Investing in ETFs
Most are passively managed, which makes a big difference when it comes to fees and commissions. The goal of these funds is to match the underlying index, not necessarily beat it, which means the average expense ratio for ETFs is far lower than the average expense ratio for mutual funds. It is also worth noting that, unlike many mutual funds, ETFs do not typically require a minimum investment amount.
Investors often consider flexibility to be an important benefit of investing in ETFs. Though ETFs include a collection of assets like mutual funds, they trade throughout the day like stocks—and as such, they can often be traded through online brokerage platforms.
Finally, one of the most important benefits of investing in ETFs is that they are fully transparent. Holdings and how they are weighted can be accessed at any time, so shareholders have visibility into the fund’s underlying assets.
Choosing the Right ETF
With hundreds of ETFs available, choosing the right ETF can seem overwhelming. These are three factors to consider when selecting the best ETF for your portfolio:
- – What is the expense ratio and how does it compare to similar ETFs?
- – How closely have returns matched their underlying index?
- – Do the underlying assets make sense for your portfolio based on your personal financial goals?
Keep in mind that niche or thematic ETFs can be interesting additions to your overall investment strategy, but the more narrow their focus, the less diversification. Therefore, consider putting the bulk of your principal into broader ETFs such as general stocks and commodities to limit your exposure to novelty funds to ensure you meet your investment goals.
Smartwealth is a platform that would allow you to diversify your investment through ETFs. It is able to match your risk appetite and financial goals by choosing the right investment for you. Save yourself the time and resources of timing the market and choosing high-risk individual stocks and spread your eggs to allow for a more strategized investment.