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What is an ETF and why are people investing in them?

ETF

Just like mutual funds, ETF that stand for exchange-traded funds are pooled investment securities. Generally, ETFs are used to track a certain index, commodity, asset, or sector. The major difference between ETFs and mutual funds is that you can buy or sell ETFs through a stock exchange. 

Another advantage of ETFs is that they can be created to keep track of numerous things such as individual commodities, enormous and varied bunch of securities, etc. They may also be used to follow particular investment strategies.

Let’s get a better understanding

The reason why an ETF is known as an exchange-traded fund is because an exchange platform is used for trading it. ETF share prices can fluctuate all day long as they continue to be bought and sold. On the other hand, mutual funds can only be traded after the market closes, that too just once every day. ETFs also have an edge over mutual funds as these are relatively more liquid and cost-effective. 

As discussed above, ETFs are like bags of multiple assets that can include stocks, commodities, bonds, or a combination of other investment types. It is entirely up to you as to what you want to add to the bag. It could be a variety of stocks from different industries or just one sector. 

Did you know that ETF is also a marketable security? Similar to Bitcoins in an instant bitcoin exchange, you can take short positions on ETFs and you can buy or sell them at any point in time with ease. 

Different types of ETF

Investors have the option of exploring different types of ETFs to generate income, speculate, and increase prices. ETFs can also come in handy to protect an investor’s portfolio through hedging. 

  • Active and passive ETF

Passive ETFs are designed to mimic the way broader equity markets, financial sectors or trends perform. These are financial instruments that tend to imitate certain index holdings that are a set of tradable assets that in a way represent a market or segment. 

Actively managed ETFs might be more expensive than passive ETFs but they also have several advantages. Active ETFs are not specific to any index but are in fact led by portfolio managers who identify and decide the securities that should be part of the portfolio. 

  • Bond ETFs

Bond ETFs are a great way to create a regular source of income for investors. How the income is distributed depends entirely on how the underlying bonds perform. These can have several options such as government bonds, corporate bonds, as well as state and local bonds also known as municipal bonds. In general, bond ETFs don’t have a set date of maturity. These are traded either at a premium or at a discounted rate from their actual prices. 

  • Stock ETFs

Stock ETFs are like bouquets of stocks from a particular industry or sector. They’re created with the goal to provide a wide range of exposure to a specific industry. If you compare stock mutual funds to stock ETFs, you will realise that these levy a lower fee, and also there’s no ownership of securities involved. 

  • Commodity ETFs

Commodity ETFs as you may have guessed by the name itself invest in commodities that may include crude oil, gold, etc. Besides diversifying a portfolio and simplifying the way downturns are mitigated, commodity ETFs have many advantages. 

Also, it is much more cost-effective to have commodity ETF shares in your possession than actual commodities as they do not require any insurance of storage-related costs for the investor. 

  • Currency ETFs

Used for tracking currency pairs’ performance, ETFs are basically large investment pools that comprise domestic as well as foreign currencies. Using Currency ETFs can be a lot like striking more than two birds with a stone. It helps you speculate on currency prices by taking into account fundamental factors like political and economic developments while also protecting against market volatility in the forex market. You can also explore the ETFs for bitcoin on select instant bitcoin exchange

How to invest in ETFs?

Trading ETF shares can be similar to trading shares simply because in both cases you would require a broker to facilitate trades. Brokerages enable access to the market in which you can either trade ETFs manually or use a robo-advisor if the hours you can commit are limited. An active investor scans the ETF market thoroughly to identify the funds that are worth investing in. It is helpful to be aware that certain ETFs bring returns in the long run while others perform best when sold short. 

Popular ETFs: Examples

  • The SPDR S&P 500 (SPY): The “Spider” keeps a track of the S&P 500 index and is the oldest and the most popular ETF. 
  • Specific to certain sectors and industries are Sector ETFs. Some of these are: oil (OIH) for energy (XLE), financial services (XLF), real estate investment trusts (IYR), and biotechnology (BBH).
  • Commodity markets like gold (GLD), silver (SLV), crude oil (USO), and natural gas (UNG) are represented by commodity ETFs. 
  • In addition to these, there are also country ETFs that are used to keep a track of primary stock indexes in different nations but are traded only in the U.S. These are also represented in U.S dollars. These include China (MCHI), Brazil (EWZ), Japan (EWJ), and Israel (EIS) to name a few. 

Why are ETFs a good choice?

  • Diversification

Just a single ETF can help you explore numerous equities, different market segments, and trends. It allows an investor to track a wide number of stocks to the extent that they can even imitate the returns a country or perhaps a group of countries can get. 

  • Trades Like a Stock

Besides allowing an investor to diversify their portfolio, ETFs also offer trading liquidity like that of equity. 

  • Lower Fees

The expense ratios are significantly lower for ETFs as these are managed passively, especially when compared to mutual funds that are generally actively managed. 

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