ETFs (Exchange Traded Funds)

Definition & Types

What Is an ETF (Exchange-Traded Fund)?

An ETF, or exchange-traded fund, is a type of investment fund that is traded on stock exchanges, much like stocks. It holds a collection of assets, such as stocks, bonds, commodities, or other securities, and is designed to track the performance of a particular market index or sector. ETFs provide investors with a convenient way to gain exposure to a diversified portfolio of assets with a single purchase, and they can be bought and sold throughout the trading day like stocks. They also provide a cost-effective way to gain diversification and professional management, which can lower the risk of investing in individual stocks.

An ETF holds a collection of assets, such as stocks, bonds, commodities, or other securities, and is designed to track the performance of a particular market index or sector.

6 Benefits to Investing in ETFs

There are several benefits to investing in ETFs:

  1. Diversification

ETFs provide investors with a convenient way to gain exposure to a diversified portfolio of assets, which can help to lower the risk of investing in individual stocks.

  1. Professional Management

Many ETFs are professionally managed, which can provide investors with access to the expertise of experienced investment managers.

  1. Low costs

ETFs typically have lower expense ratios than actively managed mutual funds, which can result in higher returns for investors over the long term.

  1. Liquidity

ETFs can be bought and sold throughout the trading day, just like stocks, which can provide investors with more flexibility when managing their investments.

  1. Tax efficiency

ETFs can be more tax-efficient than other types of investment funds, which can result in lower taxes for investors over the long term.

  1. Accessibility

ETFs are accessible to a wide range of investors, including those with limited capital, which can make it easier for individuals to invest in a diversified portfolio of assets.

6 Disadvantages of Investing in ETFs

While ETFs have many benefits, there are also some potential disadvantages to consider:

  1. Lack of Customization

ETFs are designed to track a particular market index or sector, which means that they may not meet the specific investment needs or goals of all investors.

  1. Market Risk

ETFs are subject to market risk, which means that the value of the fund can fluctuate with the performance of the underlying assets.

  1. Tracking Error

ETFs may not perfectly track the performance of the underlying assets or index, which can result in a tracking error.

  1. Short Term Fluctuations

ETFs can fluctuate in the short term in response to changes in the market conditions or investor sentiment, which can be a disadvantage for investors who are looking for more stable investments.

  1. Limited History

Some ETFs have been around for a shorter period of time and thus have a limited history, which can make it difficult to predict how they will perform in the future.

  1. Transparency

Some ETFs have a complex underlying structure and may not have full transparency on the underlying assets, which can make it difficult for investors to understand the fund's holdings and potential risks.

It's always important to do your own research and consult with a financial advisor before making any investment decisions.

Who Created the Exchange Traded Fund (ETF)?

The first ETF, the SPDR S&P 500 ETF (SPY), was created by State Street Global Advisors in 1993. The idea for the ETF was developed by a team at State Street led by Nathan Most and Steven Bloom. They were looking for a way to create a product that would give investors the benefits of a mutual fund, such as professional management and diversification, but with the added flexibility and liquidity of a stock. They came up with the idea of creating a fund that would track the S&P 500 index, and the SPDR S&P 500 ETF (SPY) was born.

The first ETF, the SPDR S&P 500 ETF (SPY), was created by State Street Global Advisors in 1993.

How Many ETFs Are There?

There are thousands of different ETFs available for investors to choose from. ETFs are offered by a wide range of issuers and track a wide variety of underlying assets, including stocks, bonds, commodities, and other securities. They can also track different market indices, such as the S&P 500, the NASDAQ, or the Dow Jones, or they can focus on specific sectors, such as technology or healthcare. Additionally, there are also actively managed ETFs which are managed by portfolio managers. The number of ETFs available and the variety of underlying assets they track is likely to continue to grow in the future.

There are thousands of different ETFs available for investors to choose from.

How Do You Buy ETFs?

There are several ways to buy ETFs:

Online Brokerage Account

One of the most common ways to buy ETFs is through an online brokerage account. Many online brokerage firms, such as E-Trade, TD Ameritrade, and Charles Schwab, allow investors to buy and sell ETFs online. You can research the ETFs you are interested in, and then place a buy order through your brokerage account.

Full-Service Brokerage

You can also buy ETFs through a full-service brokerage firm. They will provide you with a personal financial advisor who can help you to research and select ETFs that are suitable for your investment goals and risk tolerance.

Retirement Account

ETFs can also be purchased through retirement accounts such as 401(k) or IRA.

Direct Purchase

Some ETFs are available for purchase directly from the issuer. This option is usually available for ETFs that are not listed on stock exchanges and are available in limited quantity.

It's important to note that some ETFs may have minimum investment requirements, also some ETFs may also have additional fees such as purchase fee, redemption fee or account fees, so it's important to read the prospectus and understand the fees before buying. It's always a good idea to consult with a financial advisor before making any investment decisions.

What Should You Look for in an ETF?

When researching ETFs, there are several factors to consider:

Underlying Assets

Look at the underlying assets of the ETF, such as the stocks, bonds, commodities, or other securities that it holds. Understanding the composition of the ETF can help you to assess the potential risks and returns of the fund.

Expense Ratio

Look at the expense ratio of the ETF, which is the annual fee that the fund charges to cover its operating expenses. Lower expense ratios can result in higher returns for investors over the long term.

Track Record

Look at the track record of the ETF, including its historical performance, to get an idea of how it has performed over time and how it has responded to different market conditions.

Volume and Liquidity

Look at the volume and liquidity of the ETF, which will give you an idea of how easy it is to buy and sell shares of the fund. ETFs with higher volume and liquidity may be more suitable for investors who want to trade frequently.

Diversification

Look at the diversification of the ETF, which will give you an idea of how well the ETF is spread across different assets and sectors. A well-diversified ETF can help to lower the risk of investing in individual stocks.

Tax Efficiency

Look at the tax efficiency of the ETF. Some ETFs are more tax-efficient than others, and this can make a difference in the long-term returns for an investor.

Management

Look at the management of the ETF, whether it is actively managed or passive. Some investors may prefer to have a professional portfolio manager making decisions on their behalf, while others may prefer a passive investment strategy.

It's important to note that past performance does not guarantee future results and ETFs, like all investment vehicles, carry risk. It's always a good idea to consult with a financial advisor before making any investment decisions.

What Are Some Popular Examples of ETFs?

There are many popular ETFs available for investors to choose from. Some of the most popular ETFs include:

SPDR S&P 500 ETF (SPY)

This ETF tracks the S&P 500 index and is one of the oldest and most widely traded ETFs.

iShares Core S&P 500 ETF (IVV)

This ETF also tracks the S&P 500 index, and is one of the most popular ETFs for investors looking to gain broad exposure to the U.S. stock market.

Invesco QQQ ETF (QQQ)

This ETF tracks the NASDAQ-100 index and is popular among investors looking to gain exposure to technology and growth companies.

iShares MSCI EAFE ETF (EFA)

This ETF tracks the MSCI EAFE index, which is a measure of developed markets outside of the U.S. and Canada. It's popular among investors looking to gain exposure to international stocks.

SPDR Gold Trust ETF (GLD)

This ETF tracks the price of gold, and is popular among investors looking for an alternative to traditional investments, or seeking to hedge against inflation or market risk.

iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)

This ETF tracks the investment grade corporate bond market, and is popular among investors looking for a fixed income investment option.

These are just a few examples of popular ETFs, and there are many other options available depending on your investment goals and risk tolerance. It's important to do your own research and consult with a financial advisor before making any investment decisions.

ETF vs. Mutual Fund - What's the Difference?

ETFs and mutual funds are both types of investment funds, but there are several key differences between the two:

Structure

ETFs are traded on stock exchanges and can be bought and sold throughout the trading day, like stocks. Mutual funds, on the other hand, are not traded on stock exchanges and can only be bought or sold at the end of the trading day at their net asset value (NAV).

Diversification

ETFs and mutual funds both provide investors with a convenient way to gain exposure to a diversified portfolio of assets. However, mutual funds tend to have a more diversified portfolio, with a larger number of underlying assets, whereas ETFs tend to track a specific market index, sector, or theme.

Management

Mutual funds are generally actively managed by a professional portfolio manager, who makes investment decisions on behalf of the fund's investors. ETFs can be actively or passively managed, with passive ETFs tracking a specific index, and active ETFs being managed by a portfolio manager.

Expense Ratio

Mutual funds tend to have higher expense ratios than ETFs. The expense ratio is the annual fee that the fund charges to cover its operating expenses, and it can eat into your returns. ETFs tend to have lower expense ratios than mutual funds, which can result in higher returns for investors over the long term.

Tax Efficiency

ETFs tend to be more tax-efficient than mutual funds, as they generate less capital gains distributions which can trigger taxes.

Trading Flexibility

ETFs can be bought and sold throughout the trading day, like stocks, which can provide investors with more flexibility when managing their investments. Mutual funds can only be bought or sold at the end of the trading day at their net asset value (NAV).

Both ETFs and mutual funds have their own advantages and disadvantages, and the best option for an investor will depend on their individual investment goals and risk tolerance. It's always a good idea to consult with a financial advisor before making any investment decisions.

End of Lesson

Exchange-Traded Funds (ETFs) are investment funds that are traded on stock exchanges, much like stocks. They hold a collection of assets, such as stocks, bonds, commodities, or other securities, and are designed to track the performance of a particular market index or sector. ETFs provide investors with a convenient way to gain exposure to a diversified portfolio of assets with a single purchase, and they can be bought and sold throughout the trading day. They also provide a cost-effective way to gain diversification and professional management, which can lower the risk of investing in individual stocks. However, ETFs may not be suitable for all investors and it's always important to do your own research and consult with a financial advisor before making any investment decisions. ETFs have some advantages over mutual funds such as lower expenses, more tax efficiency and more liquidity.