Exchange-traded funds (ETFs) are collections of stocks or bonds, all grouped together into a single investment. ETFs trade like stocks on major stock exchanges, except instead of investing in a single stock, you're actually investing in dozens, hundreds, or even thousands of stocks or bonds at once.
ETFs are a popular investment option, especially for those who are saving for retirement. And there are a few reasons, in particular, why investing in ETFs is a smart way to save more.
1. They make it easier to diversify your portfolio
Diversification is key when investing in the stock market, because throwing all your eggs into one basket can be disastrous. If you're investing all your money in just a few individual stocks and those stocks don't perform well, your savings will be in trouble. And if you're close to retirement or already retired, a bad investment could wreck your plans for the future.
With an ETF, though, you can achieve instant diversification. A single ETF may contain hundreds or even thousands of different stocks, so if a few of those stocks take a nosedive, it likely won't have a significant effect on your portfolio as a whole.
Investing in individual stocks isn't a bad approach, but you will need to work harder to diversify your portfolio. With an ETF, diversification is made easier, and your retirement savings are more protected.
2. History is on your side in recovering from market downturns
The stock market has experienced extreme volatility over the last several months, which can be unnerving for those preparing for retirement. While you may not be able to avoid risk entirely when investing in the stock market, ETFs -- particularly index ETFs -- make it much more likely that your savings will recover from a market downturn.
Index ETFs track certain stock market indexes, such as the S&P 500, and they are considered to be one of the least risky types of investments. Because indexes like the S&P 500 are strong representations of the stock market as a whole, index ETFs are designed to follow the market. In other words, if the market is surging, your index ETF is likely performing well, too.
Of course, this also means if the stock market as a whole takes a turn for the worse, your investments will take a hit as well. Historically, though, the stock market has always bounced back from every downturn it's ever faced. That means index ETFs are very likely to recover from even the worst market crashes, which is a major advantage if you're investing for retirement.
3. They're a less research-intensive way to invest
Investing in individual stocks requires a lot of research to ensure you're investing in solid companies that will be around for the long haul. Many people simply don't want to put that kind of time into investing, and that's OK.
If you want to take a hands-off approach to investing, an index ETF may be your best bet. These are great "set it and forget it" types of investments because you can simply invest in an index ETF and then leave your money alone for decades.
On the other hand, if you want a more customized investment portfolio, you may opt to invest in niche or thematic ETFs. Unlike index ETFs that track the entire stock market, niche ETFs only contain stocks from certain industries or sectors. For example, you can invest in ETFs that focus entirely on technology, energy, real estate, or even pet care companies. This approach allows you to invest in particular areas of the stock market without having to heavily research individual companies. In addition, it limits your risk because you're still investing in a large group of securities rather than a few individual stocks.
When you're saving for retirement, where you invest matters. ETFs are a smart investment option for several reasons, and by taking advantage of them, you can save more and better protect your investments.