The Motley Fool: Are ETFs good for beginner investors?
Dr. A. Seddik Meziani: ETFs are an easy way to invest. They are rightly considered an ideal entry point into the market for fledgling investors thanks to their simplicity, low upfront cost, simple fee structure, and ease of trade. Also, beyond an ETF share price, there is no minimum amount to invest, unlike for mutual funds. Any broker can turn an investor into a new ETF holder via a straightforward brokerage account. Investors can easily access the market or submarket they want to be in. It is easily done through an ETF that tracks it.
The Motley Fool: Is an ETF considered safer than an index fund to mitigate risk? Or vice versa?
Dr. A. Seddik Meziani: To be clear, many ETFs are an “index fund” in that they also track an index, just with different terms and conditions. That being said, most ETFs can be used to mitigate risk since they are generally inherently diversified via their underlying baskets of securities which offer a widening range of asset classes. Like index funds, they cannot, however, fully eliminate risk such as market risk or counterparty and credit risk inherent in an ETF structure.
The Motley Fool: Are ETFs considered safer than stocks? Why or why not?
Dr. A. Seddik Meziani: ETFs are generally considered safer to own than individual stocks because of their wide array of underlying holdings which provide the benefits of diversification. Generally, it’s safer to hold a group of stocks rather than just one stock. In other words, ETFs eliminate exposure to individual securities risk.
The Motley Fool: How do ETFs help with diversification? Is it possible to over-diversify your ETF portfolio?
Dr. A. Seddik Meziani: Diversification is a widely accepted framework for managing investments. ETFs help with diversification especially if the underlying portfolios include multiple asset classes. But like everything else, diversification also has its limits. It should be practiced in moderation. The role of diversification is to reduce investment risk. Taking it too far, however, could lead to portfolio bloat and overdiversification. It happens when the additional benefit of reducing risk via diversification begins to be outweighed by the marginal loss of the expected return. Holding more stocks simply for the sake of having more holdings and not thinking about how the risk of each additional stock balances against the risk of the existing stocks is not a good investment strategy.