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Cut Boredom Out of Investing with ETFs

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The number of exchange-traded funds, ETFs to Wall Streeters and anyone who wants to sound like they know what they are talking about, has grown very quickly in the past few years.

Wake up!

These funds are built by finance companies, using existing stocks, in order to mimic the market movements of a certain index, industry, country or commodity.  Just a few short years ago, investors could only get this kind of multiple-stock exposure by buying all the stock in a certain industry or index or putting their money into a mutual fund that was designed to follow the movements of an index or sector of the economy.  Mutual funds have always been the main focus for many buy-and-hold investors whose only goal is to get a good rate of return so that they have a nicely funded retirement.

This approach, however, killed many a baby boomers’ retirement savings during the last economic downturn.  Besides, younger investors usually don’t have the high minimum deposits required to get into these funds.  Some minimums are low, but most funds require initial deposits that top out at thousands, if not tens of thousands, of dollars.  Since ETFs have no minimums, other than the minimum required to open an account at a discount brokerage site like Scottrade, novice investors can jump right in with a couple months’ worth of savings.

ETFs are a bit sexier than mutual funds, too.  They trade like stocks, so trading newcomers can think about issues like trading strategy and technical indicators rather than leaving all the fun (and gamble) to a crusty mutual fund manager.  This might mean a steeper learning curve and perhaps some initial losses.  However, ETFs arguably have less of a learning curve than individual stocks.

These stock-like funds are also a good option for people who think that investing is a boring undertaking.  ETFs exist for almost every industry and economic sector.  This means that new investors can find a sector that they are interested in learning about or already know about and use their knowledge to make better trading decisions and develop a winning strategy.  And, or course, like all stocks, investing in ETFs is still a gamble, so you can get the thrill of the bet while trading instead of letting the mutual fund manager have all the fun.

ETF insiders have differing options about the complexity of the trading strategy that is needed to be a successful fund trader.  Since most funds are meant to mimic a market, not a specific company, there are different variables that need to be taken into account.  In general, it is easier to spot and follow a positive trend in an industry than it is to choose a company in that industry.  A poorly run company, or a good company that runs into legal troubles or leadership troubles can fall in value even if the other companies in its sector are thriving.

On the other hand, of course, some companies can outperform  the index or industry average, meaning it is better to own the company’s stock instead of the ETF that covers all the companies in that industry.  In the end, the stock or ETF decision depends on an individual investor’s knowledge, personality, and tolerance for risk.  But for many novices, understanding and catching trends in an industry or sector is easier than finding a winning company to invest in.

Another positive of ETFs is that traders can apply more advanced techniques once they get a feel for a certain fund.  ETFs can be short-sold like stocks and advanced traders can also apply options strategies and hedging strategies.

No matter what your skill level and knowledge level, ETFs can slap you across the face just like regular stocks.  If you aren’t ready for the pain that will inevitably come from trading, you might want to stick with mutual funds and let someone else take the beating while you sit back and tell everyone that you could have done better than the pro fund manager.

What about simply following your forefather’s advice and adopting a buy-and-hold strategy with ETFs?Indexes generally go up over time.  I think the current average of 11% per year holds true over the long term, so it is possible to adopt a buy and hold strategy with certain index ETFs that follow the S&P 500 or Dow Jones Industrial Average.  It is even possible to speculate on foreign markets with ETFs.  China-focused ETFs are especially popular right now as the Middle Kingdom continues its rise to the top of the economic food chain.  Whatever your plans, ETFs are worth a look.

About Josh Lew

Josh Lew lives in the Midwestern US when he is not traveling. He is a columnist for Gadling and has contributed to Hackwriters and Skive Magazine.

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