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According to a report by management consulting firm McKinsey & Company, current Exchange Traded Fund (ETF) assets exceed $1 trillion in the United States. Despite ETFs’ popularity, you might still be unclear about what they really are — and whether they’re right for your portfolio. Here are some facts about and features of this investment vehicle that is creating such buzz.
Exchange Traded funds (ETFs) at their core are securities which derive their value from a basket of securities such as stocks, bonds, commodities or indices, and are traded similar to individual stocks on an exchange. When you purchase an ETF, you are purchasing shares of the overall portfolio, not the actual shares of the underlying investments or index components. ETFs can track a wide variety of sector-specific, country-specific and broad-market indexes. ETFs may provide diversification to your overall portfolio because one share or one unit may represent multiple underlying stocks, bonds and/or other asset classes.
Although they have existed since the early 1990s, there are now so many ETF choices that individual investors have direct access to specialty marketsthat were once cost-prohibitive and accessible only to institutional investors. The broad range of ETFs that exist today empowers investors to take part in any corner of any market at any given time without requiring a large upfront investment. Reform in 2008 enabled the creation of actively managed ETFs in addition to the passive ETFs linked to indexes.
Cost-effectiveness may be a key benefit of an ETF, particularly if you meet any or all of these criteria:
Because ETFs are traded on an exchange, transactions occur directly with investors, leading to less overhead and a lower expense ratio. If your investment strategy doesn’t meet some of the criteria above, ETFs may not deliver an advantage.
Unlike mutual funds, which assign pricing based on end-of-day net asset value, the price of an ETF changes throughout the trading day. ETFs are priced and can be purchased and sold throughout the trading day, which may give the investor some flexibility and control over the price they pay or receive when buying or selling shares. Furthermore, you can buy or sell ETF shares on a stock exchange much like the purchase or sale of any other listed stock.
Exchange Traded Funds are also subject to risks similar to those of stocks. Investment returns may fluctuate and are subject to market volatility, so that an investor's shares, when redeemed or sold, may be worth more or less than their original cost.
Sound investment strategies help you manage your risk and costs as well as consider how the various investment tools in your portfolio contribute to long-term financial goals. Meet with your financial advisor to discuss whether an ETF is an appropriate investment to add to your portfolio.
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McKinsey & Co. Financial Services Practice. “The Second Act Begins for ETFs: A disruptive investment vehicle vies for center stage in asset management"
This article was written by Pace Communications and provided for use by Wells Fargo Advisors. WellsTrade is offered through Wells Fargo Advisors, LLC. Wells Fargo Advisors is not affiliated with Pace Communications.