Most people that are new to investing are curious why there has been such an explosion in ETF popularity in recent years. Part of this is because of their flexibility, you can find a coinciding ETF for just about any type of stock, industry, geographic region or strategy that you'd like to try. You can usually own a share of the Wilshire 5000 or any other index that ETFs track for as little as $50. Can you imagine the cost if you tried to buy one share of every stock in the Wilshire 5000? Even if you could afford to buy a few shares of all 5,000 stocks, the transaction costs would make it a waste of time.
The fact that you can own a broad index when you buy into an ETF also means that you get diversification at a reasonable price, the cost of a single share. Your share will be spread over the same wide range of industries, categories and geographies as the person that owns 1,000 shares, you get the same diversification for 1/1,000th of the price.
ETFs have created an affordable way to have a professional grade portfolio that will outperform the majority of investors. A discouraging statistic for active investors is that only 20% of professional money managers beat the market returns, and this percentage is even lower for the average individual investor. ETF investors are guaranteed at least the market return for the indexes that their ETFs track so they can easily beat 80% of investors as long as they stick to the broader indexes and diversify.
Since an ETF only needs to track an Index, the fund manager will be doing a lot less buying and selling. This doesn't require a Harvard MBA and a team of analysts, the fund just rebalances occasionally to match the index that it tracks. This is why management and administrative expenses are much lower for ETFs than for the average mutual fund.
In addition to being expense efficient, ETFs are very tax efficient as well. Since trading creates the majority of tax liability, and ETFs trade infrequently (only when their index changes), they are much more tax efficient than traditional mutual funds.
You've probably heard that last one a hundred times, but here's a bit of tax info that is less well known and often misunderstood Many of the broader indexes, such as the S&P 500, track the largest and most successful companies in America. How do you get booted from S&P 500? If a company performs poorly and their market capitalization decreases (a fancy way to say the stock price drops) dramatically, they will be replaced. How does this create another ETF tax advantage? If a stock's price is dropping it is losing money. If the index (and your ETF) is only replacing stocks that are losing money, there is no capital gain to pass on to investors.
Finally, ETF investing is a low maintenance passive strategy that is easy to learn and implement in comparison to other investing strategies. What do I mean by low maintenance passive strategy? I mean you can choose several ETFs that track different broad indexes and then buy and hold and hold and hold. The simplicity of the strategy is a big perk, especially when you consider that experienced ETF investors beat most professional fund managers.
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