Why investors turn to ETFs during times of market stress

Market volatility often causes investors to shed their portfolios, which for US investors has often meant turning to exchange-traded funds, or ETFs, to refresh positions or act on new ideas.

Since the pandemic, the ETF market has roughly doubled in size — at the end of the first quarter, (ETFs) represented $7.1 trillion, or 13 percent of the U.S. stock market and 2.8 percent of the stock market. US bonds, up from $3.5 trillion. in 2019, according to BlackRock.

Todd Sohn, ETF Strategist at Strategas Asset Management, recently stopped by the Yahoo Finance Stocks in Translation podcast and highlighted some of the pros and cons of ETFs for investors.

A key advantage for ETFs is cost – fees charged to investors have fallen amid the rush to zero commissions among major brokers.

“You can buy an S&P 500 fund for 2 or 3 basis points. That’s nothing,” Sohn said.

To simply buy one share of each component of the S&P 500 would cost about $105,000. Replicating the entire index based on the weight of each stock would cost at least $15,500,000, according to Yahoo Finance’s calculations, which do not include brokerage fees. In contrast, an annual fee of 3 basis points – or 0.03% – for an ETF means an investor would pay $3 for every $1,000 invested.

ETFs also tap into a wide range of markets and strategies, which is essential for diversification.

Sohn pointed out that ETFs give investors “access to almost any market around the world.”

In addition to geographic and asset class diversification, ETFs have evolved to mimic certain hedge fund strategies. So-called smart beta ETFs, for example, use predetermined rules for selecting investments in a fund.

Sohn also pointed to transparency as a key benefit, as ETFs report holdings daily.

“I can look at the holdings every day. I know what ingredients are in my investment,” Sohn said.

ETFs are similar to mutual funds, but a key distinction is intraday liquidity. ETFs can be traded throughout the day, while mutual funds can only be bought and sold at the close.

“I can change them throughout the day if I want to,” Sohn said. “Or if I’m a big investor, I can move large amounts of money into these funds.”

Many ETFs also offer significant tax advantages, which Sohn described as their “secret sauce.”

And during periods of stress and market volatility, ETFs can act as “shock absorbers.” If an investor is worried about a stock going down, Sohn explained, “they can buy an ETF of its peers to diversify and mitigate the risk.”

The story continues

“ETFs have great value in volatile environments. They do not exacerbate any kind of market structures. They help smooth things out,” Sohn said.

On the Yahoo Finance podcast Stocks in translationeditor of Yahoo Finance Jared Blikre cuts through the market chaos, noisy numbers and hyperbole to bring you key conversations and insights from the investment landscape, giving you the critical context you need to make the right decisions for your portfolio. Find more episodes on our website video hub. Take care of yourself your favorite streaming serviceor listen and subscribe to Apple Podcasts, Spotifyor wherever you find your favorite podcasts.

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