Why investors turn to ETFs during times of market stress

Market volatility often prompts investors to kick the tires on their portfolio, 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 — as of the end of the first quarter, (ETFs) represented $7.1 trillion, or 13% of the US stock market and 2.8% of the US bond market, up from $3.5 trillion in 2019, according to BlackRock.

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

A key advantage for ETFs is cost — the fees charged to investors have plummeted amid the race to zero commissions among the big brokers.

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

To simply buy one share of each component of the S&P 500 would cost about $105,000. To replicate the entire index according to each stock’s weight would cost a minimum of $15,500,000, according to Yahoo Finance calculations, which doesn’t include brokerage commissions. In contrast, an annual fee of 3 basis points — or 0.03% — on an ETF means an investor would pay $3 for every $1,000 invested.

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

Sohn highlighted that ETFs give investors “access to virtually any market around the globe.”

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

Sohn also highlighted transparency as a key benefit, as ETFs report holdings on a daily basis.

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

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 on the close.

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

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

And during times of market stress and volatility, ETFs can act as “shock absorbers.” If an investor is concerned about a stock’s decline, Sohn explained, “they can buy an ETF of its peers to diversify and mitigate risk.”

“ETFs have great value in volatile environments. They’re not exacerbating any sort of market structures. They’re helping smooth things out,” said Sohn.

On Yahoo Finance’s podcast Stocks in Translation, Yahoo Finance editor Jared Blikre cuts through the market mayhem, noisy numbers, and hyperbole to bring you essential conversations and insights from across the investing landscape, providing you with the critical context needed to make the right decisions for your portfolio. Find more episodes on our video hub. Watch on your preferred streaming service, or listen and subscribe on Apple Podcasts, Spotify, or wherever you find your favorite podcasts.