Depending on the variety of their composition, ETFs tend to be a more diversified financial instrument when compared to a single stock which in turn makes them a less risky investment thanks to the benefits of diversification.
All financial investments carry risks but the main strategy that seasoned investors use to reduce those risks is diversification.
To show you a great example of how ETFs reduce risks, let’s take a look at one perfect example: XLI.
The XLI Industrial Select Sector SPDR Fund (XLI) is an ETF that gives investors exposure to the U.S industrial sector. Below you’ll find a chart with its price performance since the year 1999:
According to the ETF Database, one of the components of the XLI ETF is GE (General Electric Company) with a weight of 3.89%.
Now let’s take a look at GE’s (General Electric Company) price performance over the last two decades:
What do you see?
Clearly, GE is not enjoying the ride. Their stock price keeps dropping since the year 2000 and it was such a horrible ride that they decided to perform a 1-for-8 reverse stock split on July 30, 2021 in order to make their stock look better.
This example has made it as clear as possible.
The real power behind ETFs is diversification, which in the end means reducing exposure towards single assets and spreading it out across several different ones thus ensuring that not all eggs are in one basket.
ETFs give investors the opportunity to expose themselves to a basket of currencies, stocks from a particular industry, commodities, etc. Their nature as a highly configurable financial instrument makes them an amazing choice for investors looking to diversify their portfolios.