Exchange-traded funds, or ETFs, are a great investment for many people. They are traded like stocks on major exchanges, but you don't just buy shares of one company when you purchase them. Instead, you'll buy a basket of assets the fund is invested in. Many ETFs track financial indexes, such as the S&P 500, while others give you exposure to specific industries, bonds, or real estate. 

There are some big benefits of adding ETFs to your portfolio, but they aren't necessarily right for everyone. Here are three reasons you may want to invest in them, and one big reason not to. 

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Three big reasons to invest in ETFs

Here's why you may want to put your investment dollars into exchange-traded funds.

  1. Low fees: Many ETFs are passively managed, which means the fund's investments are chosen automatically to track a financial index rather than selected individually by a financial professional. These ETFs typically come with very low fees. While you can find more expensive actively managed ETFs if you want them, there are a huge number of funds with extremely low expense ratios, including thematic ETFs (with exposure to specific industries) and those that track stock market indexes. 
  2. Simplicity: Selecting an ETF can be a lot easier than picking individual stocks. Many brokerages have screeners so you can sort ETF options by fees and investment types. And you don't need to learn a lot about a company's growth strategy, leadership team, or its fundamentals, as you would with shares of individual companies. Look at what the ETF is invested in, the expense ratio, and the fund's track record. And if you don't want to do even that much research, you can really make things simple and just buy an ETF that tracks the S&P 500. That's what Warren Buffett suggests for the majority of people who won't take the time to learn to pick stocks correctly. 
  3. Rapid diversification: When you buy an ETF, your money is actually going into a big pot of cash invested in many companies. For example, if you buy the S&P 500, you're purchasing a small ownership in each of the 500 large companies that make up this financial index; if you buy a marijuana ETF, you're likely investing in growers, dispensaries, and others in the cannabis industry. Since your money is spread among all these different companies, you reduce your risk. 

And 1 big reason not to

The biggest reason not to invest in ETFs is that it's difficult or impossible to beat the market. ETFs that track market indexes, such as S&P funds, are by their nature designed to mimic the performance of the market -- not beat it. And even thematic ETFs aren't likely to see meteoric rises as the stocks of some individual companies might. 

There's a simple reason ETFs generally aren't going to give you the chance to earn the eye-popping returns you may get if you become skilled at selecting individual stocks: They aren't designed to do that. Since you're spreading your money among so many companies, you're reducing the risks associated with any one of them, but you're also limiting potential rewards. To beat the market by much, a substantial portion of the companies that the ETF is invested in would have to outperform. 

If your goal is to buy investments that beat the market, you're going to have to do the work to develop a sound investment thesis and build a portfolio around individual investments. This is riskier, but the payoff can be well worth it if you do it right.