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By charting the right course now, you can build a convenient, low-stress investing strategy that also lowers overall risk. For many, that route is toward a portfolio primarily made up of exchange-traded funds (ETF) — or any type of mutual fund, for that matter — not individual stocks.
When you purchase an ETF, the stocks included in the fund depend on the index the fund is tracking; an S&P 500 ETF, for example, would distribute your investments across all companies in the S&P 500.
Here are four reasons to consider ETFs:
1. Easy diversification. Owning a broad range of investments spreads your risk; if one company in the ETF underperforms, the losses could be offset by companies that outperform.
Put simply, if you can ignore the temptation of chasing sky-high returns, broad diversification can help you earn market-average returns relatively more predictably while lowering the risk of below-average returns.
2. Hands-off investing. If you can’t beat the market, join the market ... then forget about it. The S&P 500’s annualized total return for the last 10 years was 13.8%. That means if you had invested $5,000 in an S&P 500 ETF 10 years ago and set up automatic contributions of just $20 per month, that investment could be worth almost $25,000 today before inflation, taxes and fees — without you doing a thing.
3. Simple portfolio management. “What happens when you have a portfolio of one or two or three stocks?” asked Jim Rowley, head of investor research for Vanguard Investment Strategy Group. “Do you add a fourth stock? Do you concentrate your position even more by buying more of those one, two or three stocks?” The point: Over time, building a portfolio of individual stocks can get complicated and costly.
ETFs, on the other hand, tend to only get easier. Every contribution (including reinvested dividends) is already diversified, creating a cycle that spreads risk over time and automatically keeps you from concentrating too much in any single stock.
4. Low costs. ETFs do come with fees (known as expense ratios) that aren’t charged by individual stocks, but many are extremely affordable. For example, several of the most popular S&P 500 ETFs have expense ratios of 0.03%, or just 30 cents per year for every $1,000 invested.