There is a dizzying array of investment vehicles available to the individual investor today. Trying to find the vehicle or vehicles for your hard earned dollars can be daunting. For the amateur investor, choosing individual stocks for one’s portfolio can take hours of research and you can still be left with more questions than answers.
The gold standard of investing is diversification. This means having many different stocks from different sectors and also diversifying between stocks and other investment types. You can also diversify between different levels of company valuations or capitalization. You can have low cap stocks for lower cost, higher risk, and possibly higher returns or, at the other extreme, high cap stocks that tend to be more expensive but more sound with less risk and smaller returns.
Fortunately there are ways to expose yourself to a diversified portfolio without having to study individual stocks. Mutual funds are funds that are composed of a number of individual stocks. The stocks for each fund are picked by market experts or experts in specific market sectors.
Some funds are actively managed. The fund manager buys and sells stocks in an attempt to maximize profits. These tend to have higher fees because of having to pay the manager.
Other funds more passively follow stocks such as index funds. There are funds that simply buy the Standard & Poors 500 or The DOW. This gives you very broad diversification and your fate is pretty much tied to the overall stock market. Gains and losses come slowly and tend to be small.
Funds also track the stocks in a specific sector such as pharmaceuticals, commodities, real estate, transportation, etc. They can also become narrower and follow a single product such as oil, base metals, lumber, shipping, etc.
Exchange Traded Funds (ETFs)
Essentially, ETFs can do everything that mutual funds can do. They range from ETFs that contain a large index of stocks or an entire sector to a single product such as uranium or gold.
The biggest difference between mutual funds and ETFs is in the way they are bought and sold as well as the relative expense. ETFs are bought and sold in the same way as individual stocks. The cost of an ETF is whatever you pay your broker for the buy and sell. This makes the buying and selling of ETFs very fast.
Mutual funds take more time to buy and sell and many have minimum amounts that must be invested. They are more expensive because of fees. A managed fund is the most expensive.
One of the benefits of ETFs, in addition to the ease of buying and selling, is the ability to achieve instant diversification, as mentioned above. You can buy an index of a sector or indexes of several sectors. This way you just have to follow what sectors are doing well and not have to investigate every single stock.
Precious Metals are in a bull market currently. No one knows for sure how long it will last, but gold has made gains for the last nine years. Using this sub-sector of the commodities sector as an example, I will show you how you can play this market using ETFs.
Again, starting with greater diversification, you can buy an ETF index that tracks the larger mining companies. Unlike mutual funds, there is no minimum investment. You can buy as many or few shares as you wish. For the same kind of exposure but with higher risk, you can buy an index of junior miners.
There are ETFs that are focused more on gold miners and those more focused on silver miners or others. You can even buy ETFs that try to track the price of gold, silver, and other precious metals. This is a way to expose yourself to the precious metals bull market without having to purchase coins or bullion.
In conclusion, exchange traded funds are easy to buy and sell. They give you the option of a very broad exposure to the stock market as a whole, of specific market sectors, sub-sectors, or even individual products. With so many ETFs on the market today it is easy to imagine a solid diversified portfolio made up entirely of exchange traded funds.