Here at Cabot Investing Advice, our primary focus is stocks. But exchange-traded funds—more commonly known by their abbreviation, ETFs—can also be an efficient, profitable place to invest your money.

What is an ETF?

It’s an investment fund that trades on a public stock exchange just like a stock. ETFs hold dozens and even hundreds of stocks, commodities or bonds, so you get the safety of diversification. In that way, they’re like mutual funds.

Because they are “unmanaged,” however—you might say they run on autopilot—ETFs entail lower annual fees than comparable index-based mutual funds, and far lower fees than actively managed mutual funds. And unlike mutual funds, which are priced once a day after the market closes, ETFs are traded throughout the day just like regular stocks, so you can buy or sell them whenever you want, and when you buy, you get exactly the price quoted when you buy.

Now, of the more than 1,400 ETFs available, many are designed to mimic the performance of major indexes. You can buy indexes that duplicate the performance of the S&P 500 and the Dow Industrials. You can also buy indexes that mimic lesser-known indexes like the S&P Emerging Markets Small Cap Index and the Dow Jones Small Cap Value Index.

Those are fine for investors who are content to just do as well as the averages.

But if you want to beat the averages, you’ve got to specialize. And for that, you need sector ETFs, which allow you to invest precisely in the economic sectors you think are most likely to bring the biggest gains. 

We recommend ETFs when we feel more strongly about the sector than we do about any individual stock, or when we feel there is too much risk in any one stock, yet we still want to participate in the sector.

We also might buy an ETF if we were very confident about a bull or bear market move and wanted to leverage the move by using an ETF that aimed for double the market’s move. Our resident growth stock expert, Mike Cintolo, will occasionally invest in a major index—say, the S&P 500, by buying the SPDR S&P 500 ETF (SPY)—when he thinks it’s about to start a major upmove.

There are some instances when investing in ETFs makes sense—whether it’s gaining maximum exposure to a red-hot sector, gaining access to an entire country’s stock market, or simply taking advantage of a bull market. In general, we don’t recommend buying and holding them the way you would a stock with long-term growth potential. But there’s money to made in ETFs if you time it right.