On their surfaces, ETFs may seem simple. They offer diversification of assets and are commonly invested in a basket of stocks that aim to meet a certain investment goal. However, there are many key distinctions that make ETFs unique. Understanding the differences between varying ETFs could be crucial to your portfolio.
ETFs as Index Funds
ETFs sometimes come in the form of index funds. These often invest in a specific list of securities, such as a Dow Jones Industrial Average or S&P 500 index, that track stocks based on certain factors. The Dow Jones is a qualitative index that tracks 30 blue-chip (meaning some of the largest companies in the country that are well-known and crucial to the US economy) industrial and financial companies in the United States. The index is used by the media as a barometer of the broader stock market and the economy.[1] There are many other indexes that track different stocks or securities and have different criteria for companies to get added or dropped from them.
When it comes to an index fund, a broker will offer a fund that allows you to buy a basket of stocks that correlates to an index. Index funds may track the same index but differ in how each stock is weighted inside the fund. Some funds may also favor or screen out sectors or stocks with certain technical or fundamental traits to meet a specific investment goal.
Overall, index funds simply track the market in some form or another with less of a focus on “beating” the market.
Actively Managed ETFs
Actively managed ETFs often invest in a changing list of securities chosen by an investment manager. They may provide you with more diversification and a greater range of options and investment objectives, but index funds are often less expensive in fees. In addition, an actively managed ETF is aimed to specifically meet an investment goal and to “beat” the market. So, the holdings in an active ETF could change based on the decisions of an advisor. If the advisor is right, they could beat the market, but if they’re wrong, their decisions may underperform the market. Index funds are passively managed, and, in a sense, are the market. So, an index fund can’t underperform when compared to itself, but if the market is down in general, an active manager can see trends in the market and adjust in real-time.[2]
Over the course of many years index funds tend to outperform actively managed ETFs on average when factoring in the fees charged .[3] However, those fees may be worth it when specific investment risks are covered, and you benefit from increased diversification and flexibility.
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[2] https://www.nerdwallet.com/article/investing/index-funds-vs-mutual-funds#
[3] https://www.cnbc.com/2022/03/21/why-index-funds-are-often-a-better-bet-than-active-funds.html
The article and opinions in this publication are for general information only and are not intended to provide specific advice or Recommendations for any individual. We suggest that you consult your accountant, tax, or legal advisor with regard to your Individual situation. This content was created by Lone Beacon.
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The market indexes discussed are unmanaged and generally considered representative of their respective markets. Individuals cannot directly invest in unmanaged indexes. Past performance does not guarantee future results. The return and principal value of investments will fluctuate as market conditions change. When sold, investments may be worth more or less than their original cost. No investment strategy can guarantee a profit or protect against loss.
Diversification does not guarantee profit nor is it guaranteed to protect assets. Investors should consider the investment objectives, risks, charges and expenses of an exchange traded fund carefully before investing. The prospectus contains this and other information and should be read carefully before investing. The prospectus is available from your investment professional.
