Acorns' Investment Strategies: Understanding Their Chosen Etfs

Exchange-traded funds (ETFs) are baskets of securities that are bought and sold on an exchange, much like stocks. They are a collection of underlying assets such as stocks, bonds, and commodities. ETFs can be a great way to diversify your portfolio as they can hold a mix of stocks and bonds across asset classes, industries, or geographies. ETFs are also more flexible than other funds as they can be traded throughout the day.

Acorns, a micro-investing app, offers its users access to a selection of about 25 low-cost, diversified ETFs. These include more than 7,000 stocks and bonds. The ETFs in your Acorns portfolio could include ones like the Vanguard S&P 500 ETF, which mirrors the popular S&P500 stock index, or iShares Core U.S. Aggregate Bond ETF, which provides broad exposure to U.S. investment-grade bonds.

Acorns also offers a Bitcoin-linked ETF, allowing investors to gain exposure to Bitcoin returns in a convenient and transparent way.

The benefits of ETFs

Exchange-traded funds (ETFs) are a great way to invest in a variety of assets without the need for active management, making them a more affordable option. They are also more flexible than traditional open-end funds, as they can be traded throughout the day, and they offer better transparency and tax efficiency.

Trading flexibility

ETFs are bought and sold during the day when the markets are open, offering investors greater flexibility than traditional open-end mutual funds, which are traded only once per day after the markets close. This means that investors know within moments how much they paid to buy or received for selling ETF shares. The intraday trading of ETF shares also makes it easy to move money between specific asset classes, such as stocks, bonds, or commodities.

Portfolio diversification and risk management

ETFs can provide investors with exposure to a specific sector, style, industry, or country, helping them to quickly gain portfolio diversification. They are now traded on every major asset class, commodity, and currency in the world, and innovative new ETF structures can embody a particular investment or trading strategy. For example, through ETFs, an investor can buy or sell stock market volatility or invest continuously in the highest-yielding currencies.

Lower costs

ETFs can offer lower operating costs than traditional open-end funds, as client service-related expenses are passed on to the brokerage firms that hold the exchange-traded securities in customer accounts. Additionally, ETFs do not charge a 12b-1 fee (the annual marketing fee). The reduced administrative burden of service and record-keeping for individual clients means ETF companies have lower overheads, and these savings are passed on to investors in the form of lower fund expenses.

Potential tax benefits

ETFs are more tax-efficient than mutual funds, as they typically have lower capital gains. This means investors pay less in capital gains taxes. With mutual funds, investors incur capital gains and taxes throughout the life of the investment, whereas with ETFs, investors incur capital gains taxes only when they sell their shares.

How ETFs compare to mutual funds

Exchange-traded funds (ETFs) and mutual funds are similar in many ways. Both are professionally managed collections or "baskets" of individual stocks or bonds, overseen by professional portfolio managers, and both are less risky than investing in individual stocks and bonds. They also offer a wide variety of investment options, allowing investors to invest broadly or narrowly, depending on their personal goals and investing style.

However, there are some key differences between the two. Here's a comparison of how ETFs and mutual funds stack up:

Minimum Investment:

ETFs: ETFs can be purchased for the price of a single share, which could be as little as $50 or a few hundred dollars. There is no minimum initial investment requirement beyond the price of one share.

Mutual Funds: Mutual funds typically have a minimum initial investment, which is a flat dollar amount and isn't based on the fund's share price. For example, Vanguard mutual funds have a $3,000 minimum.

Control Over Trade Price:

ETFs: ETFs provide real-time pricing, allowing investors to use sophisticated order types and giving them more control over the price.

Mutual Funds: With mutual funds, investors get the same price as everyone else who bought and sold that day, regardless of when the order was placed. The price is calculated after the trading day is over.

Automatic Transactions:

ETFs: ETFs do not allow for automatic investments or withdrawals.

Mutual Funds: Mutual funds allow investors to set up automatic investments and withdrawals based on their preferences.

Type of Fund:

ETFs: Most ETFs are index funds or "passive" investments, meaning they are designed to track the performance of an index rather than trying to beat it.

Mutual Funds: Mutual funds can be either actively managed or index funds. Actively managed funds seek to outperform the benchmark index, while index funds track the performance of an index.

Trading:

ETFs: ETFs trade on an exchange and can be bought and sold throughout the day as share prices fluctuate, just like stocks.

Mutual Funds: Mutual fund orders are executed once per day, and all investors who bought or sold that day receive the same price.

Fees and Taxes:

ETFs: ETFs tend to have lower expense ratios than mutual funds. They are also generally more tax-efficient, as they may have lower turnover and can use the in-kind creation/redemption process to manage the cost basis of their holdings.

Mutual Funds: Mutual funds may have higher operating costs, especially if they are actively managed. They may also trigger capital gains for shareholders when securities within the fund are sold.

Transparency:

ETFs: ETFs generally disclose their holdings daily.

Mutual Funds: Mutual funds typically disclose their holdings quarterly. This longer disclosure cycle may result in style drift, where the fund's holdings stray from the intended strategy over time.

How to invest in ETFs

Exchange-traded funds (ETFs) are a great way to get started with investing in the stock market. They are a collection of securities that trade on a stock exchange, just like a stock does. ETFs can be bought and sold throughout the trading day, and their share prices fluctuate all day as they are bought and sold.

Open a brokerage account:

You need a brokerage account to buy and sell securities like ETFs. You can open an account online with many brokers offering no account minimums, transaction fees or inactivity fees. If you want a more hands-off approach, consider opening an account with a robo-advisor, which will build and manage an investment portfolio for you for a low annual fee.

Find and compare ETFs:

With your brokerage account set up, it's time to decide which ETFs to buy. You can look for the best-performing broad index ETFs or use screening tools to narrow down your options based on criteria such as asset type, geography, industry, trading performance or fund provider.

Place your order:

Navigate to the "trading" section of your brokerage account and buy the ETF using its ticker symbol. Be sure to double-check that you have the correct symbol before placing your order. Specify the number of shares you wish to buy and choose from different order types, such as market order, limit order, stop order or stop-limit order.

Relax:

Congratulations, you've bought your first ETF! These funds can form the basis of a well-diversified portfolio. There's no need to constantly check its performance, but you can access that information on your brokerage's website or by typing the ticker symbol into a search engine.

Additional considerations:

• Expense ratios: ETFs typically have low expense ratios, but this can vary, so be sure to check.
• Commissions: While many brokers have dropped commission fees, not all have, so check before buying.
• Risk: ETFs can be safer than stocks due to their inherent diversification, but the level of risk depends on the underlying assets.
• Robo-advisors: If you want a hands-off approach, consider a robo-advisor like Acorns, which offers curated ETF portfolios built and managed for you.

Examples of popular ETFs:

• SPDR S&P 500 (SPY)
• IShares Russell 2000 (IWM)
• Invesco QQQ ("cubes")
• SPDR Dow Jones Industrial Average ("diamonds")

The different types of ETFs

Exchange-Traded Funds (ETFs) are baskets of securities that are bought and sold on an exchange, and they can include a wide range of investment types. ETFs can be a great way to diversify your portfolio, as they often include different types of assets across various asset classes, industries, or geographies.

Passive ETFs

Passive ETFs are designed to track the performance of a specific index, such as the S&P 500, or a particular sector, like gold mining stocks. These ETFs aim to match the performance of the chosen index or sector, rather than trying to outperform it. This type of ETF is passively managed, meaning it doesn't require a lot of active decision-making from fund managers, which can result in lower fees for investors.

Actively Managed ETFs

On the other hand, actively managed ETFs have fund managers who actively choose which assets to include in the portfolio. These fund managers make decisions about the specific assets to buy and sell, rather than simply tracking an index. Actively managed ETFs may aim to beat the market or a specific index, but they typically come with higher fees due to the increased level of fund management.

Bond ETFs

Bond ETFs primarily hold bonds, such as government, corporate, or municipal bonds. These ETFs are often used to provide investors with a regular source of income. While they may not offer the same level of diversification as other types of ETFs, they can still be a stable option for generating consistent returns.

Stock ETFs

Stock ETFs, as the name suggests, focus on investing in stocks. These ETFs usually provide exposure to a specific industry or sector, such as technology or retail. By investing in a stock ETF, you can gain diversified access to a particular industry, including both established companies and newcomers with growth potential. Stock ETFs generally have lower fees compared to stock mutual funds, as investors don't directly own the underlying securities.

Commodity ETFs

Commodity ETFs invest in physical commodities, such as beef, soybeans, crude oil, or gold. They allow investors to gain exposure to these commodities without having to own them directly. This type of ETF can help investors diversify their portfolios and reduce their reliance on traditional stocks and bonds.

Bitcoin-Linked ETFs

Acorns, a popular investment app, offers a Bitcoin-linked ETF, providing investors with exposure to Bitcoin without requiring them to purchase Bitcoin tokens directly. This ETF, known as BITO, invests in Bitcoin futures contracts rather than the cryptocurrency itself. By investing in Bitcoin futures, investors can diversify their portfolios and potentially benefit from Bitcoin's performance without the high risk associated with direct cryptocurrency investments.

The risks of ETFs

While ETFs can be a great way to diversify your portfolio, they do come with certain risks. Here are some key points to consider:

Market Risk

Market risk is the most significant risk associated with ETFs. It refers to the possibility of losing money due to fluctuations in the financial markets. When you invest in ETFs, you take on the risk of losing money in exchange for the potential of earning higher returns. The relationship between risk and return is a fundamental concept in finance.

Underlying Asset Risk

ETF investors are exposed to the risks associated with the underlying basket of investments. For example, a bond ETF may face credit, default, and interest rate risks. It is essential to carefully review the risk section of an ETF's prospectus to understand the specific risks associated with a particular fund.

Liquidity Risk

Liquidity refers to the ease with which an investment can be converted into cash without impacting its market price. ETFs with low liquidity may have wider bid-ask spreads, leading to higher trading costs or difficulties in buying or selling the ETF.

Tracking Error

ETFs that track an index aim to deliver returns similar to that index. However, there can be a divergence between the expected and actual returns, known as tracking error. Fees are typically the biggest contributor to tracking errors.

Pricing Differences

The market price of an ETF at any given moment may not accurately reflect the exact value of its underlying assets. ETFs trade on an exchange, so investors are exposed to market forces that can cause prices to diverge from the net asset value (NAV).

Currency Risk

International ETFs are priced in local currencies, so changes in exchange rates can impact the value of your investment.

Counterparty Risk

Some ETFs, especially synthetic ETFs, rely on financial derivatives, and there is a risk that the counterparty may default.

Sector Risk

ETFs that focus on specific sectors, such as technology or healthcare, may face larger declines if that sector underperforms.

Leverage Risk

Some ETFs use leverage to amplify returns, but this also magnifies losses. These leveraged ETFs are generally riskier and not suitable for most investors.

Tax Risks

International taxes can impact your returns. It is essential to research and understand how taxes may affect your ETF returns.

Capital Risk

All financial investments carry some risk, and there is no guarantee that you will not lose money. The value of your investment and its income can vary, and there is a chance of losing your initial investment.

Risk Mitigation

While risks are inherent in any investment, there are ways to mitigate them. Diversification is one strategy, as it allows you to spread your investments across different sectors, geographies, and asset classes. However, diversification may not completely protect you from market risk, and it does not guarantee returns or eliminate the potential for loss. Therefore, it is crucial to thoroughly research and understand the risks associated with any investment before making a decision.

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