To start off, we have to ask the question – what is an ETF?
An exchange traded fund (ETF) is a kind of security that involves a collection of securities (such as stocks), which often track an underlying index and can be used to invest in any number of industry sectors or use various strategies. In simple words, an ETF is a collection of stocks or bonds which can be purchased at one price.
An ETF is called an exchange traded fund since it is traded on an exchange just like stocks. The price of an ETF’s shares will vary throughout the trading day as the shares are bought and sold on the market. This is unlike mutual funds, which are not traded on an exchange and are only traded once per day after the markets close. ETFs also tend to be more cost-effective and liquid when compared against mutual funds.
ETFs have one primary advantage over individual stocks: the diversity they have in contrast to the other. Purchasing an ETF containing dozens, if not hundreds of stocks will automatically diversify your investment over the purchase of one stock and you will be afforded some natural protection for your investment from market volatility.
- An exchange traded fund (ETF) is a basket of securities that trade on an exchange – similar to a stock
- ETF share prices fluctuate all day as the ETF is bought and sold whereas mutual funds are only traded once a day after the market closes
- ETFs can contain all types of investments including stocks, commodities, or bonds. Some offer holdings exclusive to the United States whereas others are international.
- ETFs offer low expense ratios and fewer broker commissions than buying the stocks individually would
Types of ETFs
There are various types of ETFs available to investors that can be used for income generation, speculation, price increases and to hedge or partly offset risk in an investor portfolio. Here are some of the different types of ETFs:
- Bond ETFs might include government bonds, corporate bonds, and state and local bonds—called municipal bonds.
- Industry ETFs track a particular industry such as technology, banking, or the oil and gas sector.
- Commodity ETFs invest in commodities including crude oil or gold.
- Currency ETFs invest in foreign currencies such as the Euro or Canadian dollar.
- Inverse ETFs attempt to earn gains from stock declines by shorting stocks. Shorting is selling a stock, expecting a decline in value, and repurchasing it at a lower price.
Investors should know that many inverse ETFs are exchange traded notes (ETNs) and not actual ETFs. An ETN is a bond but trades like a stock and is backed by an issuer like a bank. Be sure to check with your broker to determine if an ETN/ETF is a right fit for you.
ETFs may trade like stocks, but they actually resemble mutual funds and index funds more, which can vary greatly in terms of their underlying assets and investment goals.