:max_bytes(150000):strip_icc():format(jpeg)/GettyImages-1681105205-7c0f442d1054427fbdea7cc408ddf2a9.jpg)
| Characteristics | ETFs | Mutual funds |
|---|---|---|
| Trading and Pricing | Traded throughout the day like stocks; prices go up and down based on market conditions | Traded at the end of the day; priced once daily at net asset value (NAV) |
| Tax Efficiency | Generally more tax-efficient due to fewer taxable events | May incur more capital gains taxes from asset balancing |
| Transparency | Most disclose holdings daily | Disclose on monthly or quarterly basis |
| Cost | Fees tend to be lower due to less management | Fees tend to be higher |
| Liquidity and Minimums | Can be bought in low quantities, even fractional shares | Mutual funds may have minimums to purchase |
Common First-Time Concerns
First-time investors may be hesitant to jump into investments they have just learned about. As a financial advisor, you can address and reframe common concerns for those who are new to investing.
Here are some frequent questions people may have about ETFs:
Are ETFs Risky?
Not all ETFs carry high risks, as this depends on the assets held by the fund. All investing does carry some inherent risk, as returns aren’t guaranteed, but you can choose the type of ETF you want to invest in based on your desired risk level. There are ETFs created specifically as low-volatility investments for those who are risk-averse.
While choosing low-volatility ETFs doesn’t eliminate all risk, it can significantly reduce it. An ETF tracking the S&P 500 index, for example, would need something to happen to the 500 largest publicly traded companies in the U.S., which is altogether different from envisioning simply a single firm going belly up.
Can I Lose All My Money?
Technically, yes, there is risk associated with any type of investment, which is why understanding exactly how each type of investment performs is important. ETFs come in all shapes, sizes, and asset combinations. Choosing an ETF should be based on what you are looking to add to your investment portfolio. .
Important
Prioritizing diversity among your investments helps protect against loss if one type of asset or sector undergoes significant volatility.
Are ETFs for Day Traders?
ETFs can be used for both short-term and long-term investors, including day traders. However, most ETFs are designed for long-term investors who buy and then hold onto their shares to add stability and diversification to their portfolios.
ETFs can be bought and sold like individual stocks, which allows day traders to incorporate them into their investment strategies, too.
How ETFs Work for Long-Term Investment Strategies
For most people, investing is a long-term strategy to build wealth and financial stability for their future. ETFs fit nicely into this type of investment portfolio thanks to the built-in diversification and low-cost access. Because most ETFs are designed to track specific benchmarks or mirror market returns (such as funds that track the S&P 500 index), they are well-suited for passive investors who prefer a “set it and forget it” approach.
For this reason, Warren Buffett famously suggested that, for most people, investing in a low-cost fund that tracks the performance of the S&P 500, such as the Vanguard S&P 500 ETF (VOO), is the best course of action. That’s because, historically, these funds have shown significant gains while being less volatile than riskier investments.
In addition, there are target-date ETFs based on an investor’s anticipated retirement year. This type of ETF is rebalanced periodically to reflect the current distance from the target date, just as with the popular target-date mutual funds. Further out from the target date set for the fund, this type of ETF may contain higher-risk stocks, but it reallocates to more conservative holdings as the retirement year approaches.
Empowering Clients Through ETF Education
While your clients may know more than the average person, they likely could still benefit from clear explanations, especially as their portfolio grows more complex. The goal isn’t just to recommend ETFs; it’s to build their confidence in understanding what they own.
You can begin with the fundamental concept: While an ETF trades like a single stock, your client is actually purchasing a collection of investments. You can make this tangible by walking them through a real example. Pull up an ETF they’re considering and show them exactly where to find its holdings online.
New investors need to understand ETFs are available across all types of asset classes, sectors, and levels of expected volatility. Explain that holding an ETF can help improve your portfolio distribution and risk tolerance, because they hold multiple assets (stocks, bonds, etc.) within that one fund, but that really depends on the type of ETF they choose to invest in.
For example, explaining that investing in a cryptocurrency ETF isn’t safer or less risky than investing in cryptocurrency directly just because it’s an ETF. A crypto-based ETF may offer diversification, but the asset class carries more risk and volatility.
How Do I Explain ETF dividends To Clients Used to Dividends From Individual Stocks?
Many clients understand that some stocks pay dividends, but they might be surprised to learn that ETFs can pay dividends too—and in some cases, more predictably. When an ETF holds dividend-paying stocks, it collects all those dividend payments and distributes them to ETF shareholders, typically on a quarterly basis. The key advantage is consistency: even if one company in the ETF cuts its dividend, the client still receives payments from all the other dividend-paying companies in the fund.
For clients focused on income, a dividend-focused ETF like Vanguard Dividend Appreciation ETF (VIG) holds dozens of companies with strong dividend track records, so the client isn’t dependent on any single company’s dividend policy.
When Should I Recommend Sector-Specific ETFs vs. Broad Market ETFs for New Investors?
For most new investors, broad-market ETFs should form the foundation of their investment portfolio. However, sector-specific ETFs can play a strategic role once clients have that broad foundation in place. They’re useful for when conviction plays and geographic balance. Sector ETFs tend to be more volatile than broad market funds, so they require more monitoring and may not suit clients who prefer a hands-off approach.
How Do I Talk To Clients Who Want to Time the Market with ETFs?
The ability to trade ETFs throughout the day often triggers clients’ desire to time the market, especially during volatile periods. You can start by validating their instinct—it’s natural to want to “do something” when markets are moving dramatically. Then reframe the conversation around what actually drives long-term wealth building: time in the market, not timing the market.
The Bottom Line
ETFs are easily accessible and strategic tools available to investors. Lower costs, built-in diversification, and liquidity make them especially valuable for beginners, but clients need a good understanding of how they work and why they’re worth adding to your portfolio.
Introducing ETFs to clients isn’t just about recommending a product. It’s about building their financial literacy, clearing up any confusion, and empowering them as you help craft their financial future. When you take the time to explain ETFs clearly and thoughtfully, you’re not just helping grow a portfolio; you are strengthening the trust your clients have with you. And that trust is often what leads to long-term success for both of you.
