MORE LIKE THISInvestingFunds
Diversification is hard work. A well-rounded investor may own stock in dozens or even hundreds of publicly-traded companies — and stock research on all of those companies can take a lot of time.
One workaround is to invest in exchange-traded funds (ETFs). These are baskets of companies that trade on exchanges like the New York Stock Exchange and the Nasdaq, just like stocks, and can provide exposure to many stocks with a single purchase.
The best ETF for you will depend on your particular goals. More risk-averse investors with shorter investing timelines may gravitate toward conservative ETFs that focus on preserving capital, while more risk-tolerant investors with longer timelines may gravitate to equity ETFs with greater potential returns (but also greater potential volatility).
Best ETFs as of May 2024
Below is a list of the best ETFs with expense ratios below 0.5% that hold large U.S.-based companies, in terms of five-year performance. Leveraged ETFs, inverse ETFs and hedged ETFs are excluded.
Ticker | Fund name | 5-year return |
|---|---|---|
SMH | VanEck Semiconductor ETF | 31.19% |
SOXX | iShares Semiconductor ETF | 26.35% |
XLK | Technology Select Sector SPDR Fund | 21.30% |
IYW | iShares U.S. Technology ETF | 20.70% |
FTEC | Fidelity MSCI Information Technology Index ETF | 19.57% |
Source: VettaFi. Data is current as of May 1, 2024, and is for informational purposes only.
ETF advantages and disadvantages
ETF pros
Investors have flocked to exchange traded funds because of their simplicity, relative cheapness and access to a diversified product. Here are the pros:
Diversification
While it’s easy to think of diversification in the sense of the broad market verticals — stocks, bonds or a particular commodity, for example — ETFs also let investors diversify across horizontals, like industries. It would take a lot of money and effort to buy all the components of a particular basket, but with the click of a button, an ETF delivers those benefits to your portfolio. Diversification can help safeguard your portfolio against market volatility. If you invested in just one industry, and that industry had a really bad year, it's likely your portfolio would have performed poorly too. By investing across different industries, company sizes, geographies and more, you give your portfolio more balance. Because ETFs are already well-diversified, you don't have to worry about creating diversification within your portfolio.
Advertisem*nt
Fidelity | Merrill Edge® Self-Directed | E*TRADE |
|---|---|---|
NerdWallet rating 5.0/5 | NerdWallet rating 4.2/5 | NerdWallet rating 4.4/5 |
Fees $0 per trade for online U.S. stocks and ETFs | Fees $0 per trade | Fees $0 per trade. Other fees apply. |
Account minimum $0 | Account minimum $0 | Account minimum $0 |
Promotion None no promotion available at this time | Promotion None no promotion available at this time | Promotion Get up to $1,000 when you open and fund an E*TRADE account |
Learn More | Read review | Learn More |
Transparency
Anyone with internet access can search the price activity for a particular ETF on an exchange. In addition, a fund’s holdings are disclosed each day to the public, whereas that happens monthly or quarterly with mutual funds. This transparency allows you to keep a close eye on what you're invested in. Say you really don't want to be invested in oil — you'd be able to spot those additions to your ETF more easily than with a mutual fund.
Tax benefits
ETFs have two major tax advantages over mutual funds.
If you invest in a mutual fund, you may have to pay capital gains taxes (or, the profits from the sale of an asset, like a stock) through the lifetime of your investment. This is because mutual funds, particularly those that are actively managed, often trade assets more frequently than ETFs. Most ETFs, on the other hand, only incur capital gains taxes when you go to sell the investment. This means you'll pay less tax on your ETF investment overall.
As mutual fund managers are actively buying and selling investments, and incurring capital gains taxes along the way, the investor may be exposed to both long-term and short-term capital gains tax. If you're invested in an ETF, you get to decide when to sell, making it easier to avoid those higher short-term capital gains tax rates.
» Related: Best-performing high-dividend ETFs
ETF cons
Exchange traded funds may work well for some investors, but they aren't perfect. Here are the cons:
Trading costs
ETF costs may not end with the expense ratio. Because ETFs are exchange-traded, they may be subject to commission fees from online brokers. Many brokers have decided to drop their ETF commissions to zero, but not all have.
Potential liquidity issues
As with any security, you’ll be at the whim of the current market prices when it comes time to sell, but ETFs that aren’t traded as frequently can be harder to unload.
Track your finances all in one place
Find ways to invest more by tracking your income and net worth on NerdWallet.
Risk the ETF will close
The primary reason this happens is that a fund hasn’t brought in enough assets to cover administrative costs. The biggest inconvenience of a shuttered ETF is that investors must sell sooner than they may have intended — and possibly at a loss. There’s also the annoyance of having to reinvest that money and the potential for an unexpected tax burden.
More reading about ETFs
How to invest in ETFs.
Best-performing semiconductor ETFs.
Bitcoin ETFs.
Frequently asked questions
Are these the best ETFs for me?
The best ETFs for your portfolio will depend on your circ*mstances and goals. It's a good idea to talk to a financial advisor if you're not sure what type of ETF is right for you.
What should I look for when choosing an ETF?
It's good to check an ETF's historical returns, expense ratio and holdings before buying it.
Neither the author nor editor held positions in the aforementioned investments at the time of publication.
