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The Benefits of Investing in ETFs and Bond Funds
There is no magic bullet or guarantees in investing. Investment theory suggests
that if your portfolio is diversified you will increase your chances of a
rewarding investing experience by decreasing your risk. ETFs simplify your
diversification effort and offer you a wide array of investment strategies.
What are ETFs?
ETFs are investment companies that trade in the secondary market as ETF shares.
ETFs are index-based products, in that each ETF holds a portfolio of securities
that is intended to provide investment results that generally correspond to the
price and yield performance of the underlying benchmark index.
ETFs add the flexibility, ease and liquidity of stock trading to the benefits of
traditional index fund investing. ETFs can be traded intraday. You can buy or
sell shares in the collective performance of an entire stock or bond portfolio
as a single security.
As an example, the Diamonds (DIA) that trade on the American Stock Exchange is
an exchange traded fund (ETF) that represents all 30 stocks in the Dow Jones
Industrial Average.You can buy and sell Diamonds like a stock and have the
performance and income of the 30 diverse stocks in the Dow Jones Industrial
Average.
Over 100 ETFs trade on the American Stock Exchange. Some of the other ETFs are
the QQQ for the NASDAQ 100 Index, the SPY for the S&P 500 Stock Tracking
Index and the IEF for the ishares of Lehman 7 to 10 year Treasury Bond index.
These (and many others) are available to you through MSFS.
ETFs, in general, have significantly lower annual expense ratios than other
investment products because they are index-based, not "actively" managed. ETFs
do have expenses and brokerage commissions apply to ETF buy and sell
transactions.
ETFs began with funds that tracked equity indexes. The ETFs have now expanded to
fixed income ETFs that are designed to generally track bond market indexes. You
might consider purchasing and holding fixed income ETFs to diversify an equity
portfolio as fixed income ETFs often trade in an inverse relationship to
equities and have been less volatile than equities.
Income
Dividends paid by companies and interest paid on bonds held in an ETF are
distributed to ETF holders, less expenses, on a pro rata basis. Fixed income
investments are often used as a source of regular income, and fixed income ETFs
declare and pay dividends, if any, on a monthly basis.
Advantages
ETFs offer individual investors:
• advantages of stocks and index funds combined
• lower fees (ordinary brokerage commissions apply)
• buying and selling flexibility
• wide array of investment strategies, including core holding
and diversification
• convenient vehicles for allocating assets to both equity
and fixed income
• income opportunities, either dividends or bond interest
income
Risks
ETF shareholders are subject to risks similar to those of holders of other
diversified portfolios.
A primary risk consideration is that the general level of stock or bond prices
may decline affecting the value of an equity or fixed income ETF. An ETF
represents interest in a portfolio of securities. When interest rates rise bond
prices decline adversely affecting the value of fixed income ETFs. The overall
depth and liquidity of the secondary equity market will fluctuate.
An exchange traded sector fund may also be adversely affected by the performance
of that specific sector or group of industries on which it is based.
Although ETFs are designed to provide investment results that generally
correspond to the price and yield performance of their respective underlying
indexes, the trusts may not be able to exactly replicate the performance of the
indexes because of trust expenses and other factors.
Summary
You may wish consider the benefits offered by the simplification,
diversification and wide selection of ETFs in designing your investment
portfolio.
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