Over the last 40 years, the way individuals invest has evolved in five stages or eras, with each stage of the evolution marked by its own set of tools and preferences. Each era has also been marked by progressively greater benefits, but also many drawbacks and disadvantages.

However, I believe the era of investing we are in today offers the greatest opportunities and advantages that individual investors have ever had access to. That means your ability to profit, while taking on less risk, is greater today than ever before. Let me show you what I mean.

The following are what I refer to as the five “eras” of individual investing, along with some of the benefits and drawbacks for each one:

Individual Investing 1.0 – Mutual Funds

Mutual funds began to gain prominence in the 1970s and really took off in the 80s and 90s. The primary advantage of mutual funds is that they can mitigate risk through wide diversification – something that used to be very difficult for individual investors to accomplish with a small portfolio. There are also a wide range of styles, managers and sector-specific funds to choose from.

But there are MANY disadvantages to mutual funds as well. They can only be bought and sold at the end of the day. Most managers under-perform their targets. The fees can be expensive. You can be hit with capital gains taxes, due to sales of securities inside the fund (even if you don’t sell your shares). And mutual funds generally only work in a bull market (although today there are many more choices than there were 20 years ago).

In 2008, with no bull market in place, investors lost almost $3.7 trillion in mutual funds, according to the mutual fund industry’s own Investment Company Institute.

Investing 2.0 – Investing with a Broker

In the 1980s and 90s the number of individual stock market accounts exploded. And at that time, the only way to trade was through a broker. There are many very good brokers out there. But there are many more who have no idea what they’re doing. Others push the products and stocks their firms want them to push (often with conflicts of interest attached).

Brokers also have a strong bias towards buying stocks and keeping you in the market. Not too many brokers would tell their clients, “I expect this bear market to be a ripper. What do you think about liquidating and sitting on cash for a year or two?”

Investing 3.0 – Online Investing

Since the late 90s we have seen a massive shift away from broker-assisted trades to online investing where the investors executes his own buys and sells. This has fostered an era of lower costs and much greater convenience. But it has been offset by much greater risk.

Millions of investors took charge of their own accounts. And many of them were not qualified in the least to do so. With dollar signs in their eyes and an itchy trigger finger on the mouse, they approached the management of their life savings as it if were a video game. They chased internet stock tips. They ‘dabbled’ in options and day trading. And they bought when exuberance was high and sold when despair was in the air – exactly the opposite of what an experienced investor would do.

Investing 4.0 – Hedge Funds

The 2000s ushered in the era of hedge funds. And there are many advantages to hedge funds. They offered coverage of markets and access to investment classes that were formerly completely out of reach for most investors. And when hedge funds do well, they can do REALLY well.

But they are also very exclusive and exclusionary. They are not transparent, so you have little idea where your money invested at any given time. And they are expensive, with most funds taking 2% of assets under management, plus 20% of the gains. But the biggest drawback to this fee structure wasn’t the cost, it was the “heads I win, tails you lose” nature of the relationship. Funds that are structured this way have strong incentives to jack up the risk to boost the gains. But if their bets go wrong… it’s your money that gets flushed.

Investing 5.0 – Exchange Traded Funds

This decade has also ushered in the era of Exchange Traded Funds (ETFs). When used properly, ETFs can offer you all the advantage of what has come before, but with almost none of the drawbacks. ETFs have truly leveled the playing field for individual investors, allowing us to accomplish things that only the largest institutional investors could do just a few years ago. Learn how to use the wide world of ETFs in your portfolio and you can invest with greater safety, lower costs, more diversification and higher profits than ever before.

Here are just some of the advantages of Exchange Traded Funds:

•    Instant diversification – Like a mutual fund, ETFs hold a diversified basket of securities. In the case of stocks, this provides significant protection against “company-specific risk” and “gap risk” – where one bad earnings report, fraud, scandal or a natural disaster could send shares plummeting past your stop point. And this can be especially important when leverage is involved. Many traders prefer to trade options on ETFs for this very reason – because it is safer to apply leverage on a diversified financial asset.

•    Trade just like a stock – While ETFs provide all the benefits of a mutual fund, they trade like stocks. That means you can buy and sell at any time during the day. You can short them. You can buy or sell options on them. You can use limit orders to buy or sell. And most ETFs are very liquid, so you can get in and out of positions quickly and without paying a hefty price.

•    Invest in a Variety of Assets – ETFs allow you to carve up the universe of stocks and asset classes exactly as you see fit. There are ETFs for specific industries… specific geographic areas… different currencies… different market caps… as well as long, short and leveraged ETFs of every variety.

•    Trade the hottest sectors – You can buy a great company in a lousy sector and do poorly. On the other hand, you can buy a lousy company in a hot sector and make a fortune. A great deal of investing success is about having your money in the right sectors (and geographic areas) at the right time. Depending on where we are in the economic cycle, earnings flow into different sectors of the economy. The key is to put this market volatility to work in your favor. And ETFs allow you to do that with precision.

•    Cheap, easy and tax efficient – ETFs have no redemption fees when you close your position, unlike many mutual funds. They have MUCH lower annual fees. They are also more tax efficient than mutual funds, where you can be hit with capital gains due to active buying and selling within the fund (even if you don’t sell your shares). And there is no minimum investment – you can buy just one share if you wanted to.

The bottom line is that ETFs offer every advantage that we have accrued as individual investors over the last 40 years, but with very few of the disadvantages. They offer the safety and diversification of mutual funds. They allow you to invest in just about every nook and cranny of the investment world, the same way that hedge funds and institutions have been able to do for decades.

They allow you to profit in an up or down market and to hedge your portfolio against risk. They are fully transparent, so you know what is in your portfolio at any given time (the same can’t be said for mutual funds or hedge funds). And they allow you to fully customize your own portfolio, with full control of your investments.

If you wish to be a complete investor… a safe investor… and a successful investor, you should incorporate ETFs into your portfolio. And if you’re looking for advice on how to do this safely and profitably, may I suggest my colleague Andrew Gordon, who is an expert on international investing and sector rotation. He will soon be releasing a research service focused on ETFs. You can put your name on the list for some free picks and to receive first notification when the service opens. Visit here if you’re interested.

To Your Success,

Jon Herring