It’s no secret that Exchange-Traded Funds (ETFs) have become one of the most popular investment vehicles in recent years. ETFs, offer many advantages over traditional mutual funds, including lower costs, greater tax efficiency, and more transparency. But can they be kept for the long term? We’ll look at some of the factors you need to consider when making that decision.
What are ETFs, and why are they becoming more popular investment vehicles?
An ETF is an investment fund that trades on an exchange, just like stocks. Unlike traditional mutual funds, which are bought and sold at the end of the day, ETFs can be bought and sold throughout the day. ETFs typically have lower fees than mutual funds and are more tax-efficient because they generate fewer capital gains.
ETFs have become increasingly popular as investors seek to maximise returns while minimising costs. According to a report by Morningstar, global ETF assets under management (AUM) grew from $2 trillion in 2016 to $4 trillion in 2018. In the United States alone, AUM grew from $1.6 trillion to $3.4 trillion over the same period. Today, they remain equally attractive and it is a rapidly growing part of the trading world.
What are the benefits of holding ETFs for the long term?
There are many benefits to holding ETFs for the long term. For starters, ETFs offer greater diversification than traditional mutual funds. By investing in a variety of different ETFs, you can be spreading your risk across a wide range of asset classes, industries, and geographical regions. This diversification can help you weather market volatility and achieve your long-term investment goals.
Another benefit of holding ETFs for the long term is that they tend to have lower fees than actively-managed mutual funds. Actively-managed funds incur higher costs due to the need to pay fund managers for their expertise. Over time, these higher fees can eat into your returns.
ETFs are also more tax-efficient than traditional mutual funds. It is because they generate fewer capital gains, which are taxed at a higher rate than ordinary income.
Finally, ETFs offer greater transparency than mutual funds. With an ETF, you always know what you’re buying and what it’s worth. With a mutual fund, on the other hand, the composition of the portfolio can change over time, making it difficult to track your performance.
What are some of the risks associated with holding ETFs for the long term?
There are a few risks to consider before investing in ETFs for the long term. First and foremost, ETFs are subject to market risk, just like any other investment. It means that their value can go up or down in response to changes in the underlying asset prices.
To mitigate this risk, it’s essential to diversify your ETF portfolio across various asset classes, industries, and geographical regions. It will help you weather market volatility and achieve your long-term investment goals.
Another risk to consider is that some ETFs are more volatile than others. For example, leveraged ETFs use financial derivatives to amplify the returns of the underlying assets. It can lead to higher gains in bull markets and more significant losses in bear markets. Inverse ETFs, which bet against the performance of an index or sector, can also be volatile.
How long can you keep an ETF before it becomes stale?
Investors often ask how long they can hold an ETF before it becomes ‘stale’. The answer depends on many factors, including ETF type, underlying assets, and investment goals.
Some ETFs, such as those that track major market indexes, can be held for long periods without becoming stale. It is because the underlying assets tend to be large, well-established companies that aren’t likely to experience sudden business changes.
Other ETFs, such as sector and international funds, can become stale more quickly. It is because the underlying assets are typically more volatile and may be impacted by changes in global economic conditions.
Generally, you should review your ETF holdings at least once yearly to ensure that they align with your investment goals. If you find that an ETF has become stale, you can sell it and invest the proceeds in a more recent fund.
