What Is an Exchange-Traded Fund (ETF)?

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Similar to a mutual fund, an exchange-traded fund (ETF) is a kind of pooled investment asset. ETFs can be bought or sold on a stock market in the same manner as conventional stocks, unlike mutual funds, but they usually follow a specific index, sector, commodity, or other asset. An exchange-traded fund (ETF) has the capacity to monitor many asset classes, ranging from a broad assortment of securities to the value of a single commodity. Even certain investing techniques can be tracked by ETFs.

The SPDR S&P 500 ETF (SPY), which tracks the S&P 500 Index, was the first exchange-traded fund (ETF) and is still in use today.

Knowing Your Way Around Exchange-Traded Funds

Because an exchange-traded fund (ETF) is exchanged on an exchange like stocks, it is also known as an exchange-traded fund. As shares of an ETF are purchased and sold on the market, their price will fluctuate during the trading day. This is not the case with mutual funds, which trade just once a day after the markets shut and are not traded on an exchange. In addition, compared to mutual funds, exchange-traded funds (ETFs) are often more affordable and liquid.

Unlike stocks, which only hold one underlying asset, exchange-traded funds (ETFs) hold several underlying assets. ETFs are a popular option for diversification since they contain a variety of assets. Thus, equities, bonds, commodities, and a variety of other investment kinds can all be found in ETFs.

An ETF may be limited to a single industry or sector, or it may own hundreds or thousands of equities in a variety of industries. While some funds have a worldwide vision, others concentrate solely on U.S. offers. ETFs with a focus on banking, for instance, would own equities of different banks from throughout the sector.

An exchange-traded fund (ETF) is a marketable investment, which means that its share price makes it simple to buy, sell, and trade it short on exchanges throughout the day. Except in cases where later regulations have changed their regulatory requirements, the majority of exchange-traded funds (ETFs) in the US are structured as open-ended funds and are governed under the Investment Company Act of 1940. The number of investors in an open-end fund is not restricted.

Types of ETFs

Investors can employ a variety of exchange-traded funds (ETFs) for income creation, speculation, price rises, and risk hedging or partial portfolio offset. A synopsis of a few of the ETFs that are currently offered on the market is provided below.

Passive and Active ETFs

ETFs are often classified as actively or passively managed. ETFs that are passive seek to mimic the performance of a larger index, such as the S&P 500, which is a diversified index, or a more focused sector or trend. Gold mining stocks are one example of the latter group. As of October 13, 2023, there are around nine exchange-traded funds (ETFs) that concentrate on firms involved in the gold mining industry, with the exception of inverse, leveraged, and funds with minimal assets under management (AUM).

Typically, actively managed exchange-traded funds (ETFs) do not aim to track an index of stocks; instead, portfolio managers make choices about which assets to add to the portfolio. Although these products are often more expensive for investors, they provide advantages over passive ETFs. Below, we examine actively managed ETFs.

Bond ETFs

Investors can utilize bond ETFs to generate consistent income. The performance of the underlying bonds affects how their income is distributed. These might consist of corporate bonds, state and local bonds, or municipal bonds issued by governments. The maturity date of bond ETFs is not the same as that of their underlying securities. Typically, they are traded above or below the bond’s face value.

Stock ETFs

An industry or sector is tracked by a portfolio of companies in stock exchange-traded funds (ETFs). An ETF for equities, for instance, may follow international or auto companies. The objective is to offer a variety of perspectives on a single industry, one that encompasses both established players and recently emerged players with room to develop. Stock ETFs are less expensive than stock mutual funds and do not require actual stock ownership.

Industry/Sector ETFs

ETFs that concentrate on a particular business or sector are known as industry or sector ETFs. An energy sector exchange-traded fund (ETF) comprises firms that are involved in the industry. By monitoring the performance of businesses in that industry, industry exchange-traded funds (ETFs) aim to provide investors with exposure to the positive aspects of that sector.

The IT industry is one instance, which has seen a rise in funding recently. However, because ETFs do not entail direct ownership of shares, the downside of erratic stock performance is also limited. During economic cycles, industry exchange-traded funds (ETFs) are also utilized for sector rotation.

Commodity ETFs

Commodity exchange-traded funds (ETFs) invest in commodities, such as gold or crude oil, as their name suggests. ETFs that track commodities have several advantages. They first diversify a portfolio, which facilitates the hedging of downturns.

Commodity exchange-traded funds, for instance, can provide as a buffer when the stock market is down. Second, investing in a commodities exchange-traded fund (ETF) is less expensive than acquiring the commodity itself. This is so because the former omits the need for storage and insurance.

Currency ETFs

Exchange-traded funds (ETFs) that follow the performance of currency pairings—that is, combinations of local and foreign currencies—are called currency pairs. Currency ETFs have several uses. Based on a nation’s political and economic trends, they may be utilized to speculate on currency values. Additionally, importers and exporters utilize them to diversify their holdings or protect themselves from currency market volatility. A few are also employed as a hedge against the possibility of inflation. Even an ETF option exists for bitcoin.

Inverse ETFs

By shorting equities, inverse ETFs try to profit from stock falls. Selling a stock, anticipating a drop in value, and then buying it back at a reduced cost is known as shorting. Derivatives are used by an inverse ETF to short a stock. They are essentially wagers on the market’s downturn.

A proportional gain occurs in an inverse ETF when the market decreases. The fact that many inverse ETFs are exchange-traded notes (ETNs) rather than actual ETFs should be known by investors. An ETN is a bond that is backed by an issuer, such as a bank, and trades like a stock. To find out if an ETN is a good fit for your portfolio, be sure to speak with your broker.

Leveraged ETFs

An ETF that is leveraged aims to yield returns that are multiples of the return on the underlying assets, such as 2× or 3×. For example, a 2× leveraged S&P 500 ETF will gain 2% if the S&P 500 increases by 1% (while the ETF would lose 2% if the index falls by 1%). These products leverage their returns through the use of derivatives, including futures contracts or options. Leveraged inverse ETFs are another option; they aim for an inverse multiplied return.

How to Buy ETFs

Investing in ETFs has become very simple for traders because to the abundance of platforms accessible. To start investing in ETFs, adhere to the instructions provided below.

Find an Investing Platform

The majority of online investment platforms, websites that provide retirement accounts, and investing applications like Robinhood all carry ETFs. The majority of these platforms allow commission-free trading, which eliminates the need for you to pay platform providers’ fees in order to purchase or sell ETFs.

A commission-free buy or sell does not, nevertheless, imply that the ETF supplier would also offer free access to their offering. Convenience, services, and product diversity are some ways platform services set themselves apart from competitors.

For instance, investment applications for smartphones make it possible to buy ETF shares with just a single tap. This might not apply to all brokerages, as some might need documentation from investors or have more complex requirements. However, a few well-known brokerages provide a wealth of instructional materials to assist novice investors in learning about and conducting research on exchange-traded funds (ETFs).

Research ETFs

Investigating ETFs is the second—and most crucial—step in the investment process. The markets currently provide a large range of exchange-traded funds (ETFs). When conducting research, keep in mind that exchange-traded funds (ETFs) differ from individual assets like stocks and bonds.

When you invest in an ETF, you must take the industry or sector as a whole into account. While conducting your study, you may want to think about the following questions:

  • How long do you plan to invest?
  • Do you invest for growth or income?
  • Are there any specific industries or financial products that pique your interest?

Consider a Trading Strategy

Dollar-cost averaging, or spreading out your investment fees over time, is a useful trading approach if you are a novice investor in ETFs. This is due to the fact that it evens out results over time and guarantees a methodical approach to investing, as opposed to a random or erratic one.

It also aids in the education of novice investors on the subtleties of ETF investment. Investors can advance to more complex tactics like swing trading and sector rotation as they gain confidence in their trading abilities.


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