What is an Exchange-Traded Fund (ETF)?
This could be made up of stocks, commodities, bonds or other securities. An example of this is the S&P 500, which includes the 500 largest public companies in the US. ETFs are therefore “passive” investment funds, meaning that they’re built to match the market, an industry, or a certain type of company by mirroring their performance.
“ETF” stands for Exchange-Traded Fund, named because it's traded on an exchange just like stocks. Like stocks, the price of ETFs change throughout the day as the shares are bought and sold on the market. When you buy shares of an ETF, you’re therefore actually getting a little bit of ownership in many investments all at once - great for diversification!
KEY TAKEAWAYS
- ETFs are a type of passive investment fund that tracks a combination of stocks, commodities, bonds or other securities held within an index
- Example include the S&P 500, FTSE 100 and The Dow Jones
- ETFs are good place to start when investing as it allows you to invest in multiple investments at once
- They have lower fees than actively managed funds as they don't require an expert to move investments around on your behalf
How to buy and invest in ETFs
So, you are probably wondering how to buy ETFs? It’s quite simple. You get access to trade ETFs through an online trading platform, just like stocks. There are many ETFs to choose from. That is why most trading platforms have included different filters, such as “risk” and “country”, which you can use in order to narrow down the options. Once you have found an ETF that looks interesting, you might want to know what companies are in the fund, as well as its historical performance. All this information is accessible on the trading platform.
Pros of ETFs
- Diversification: Diversification is key to becoming a successful long-term investor. When diversifying your portfolio, you spread out your risk across different investments. If one investment then goes down, the others may compensate for it. Because an ETF includes many different securities, it can help reduce your portfolio's overall risk.
- Low fees: All investment funds come with management fees, which pay the fund’s managers. Because ETF's are passive, they do not require much maintenance, and therefore ETFs have lower fees than actively managed funds.
Cons of ETFs
- The costs could be higher: Most people compare trading ETFs with trading other funds, seeing that ETFs have lower annual costs. But if you compare ETFs to investing in single stocks, the costs are higher, as there are no annual fees when trading single stocks.
How does an ETF make money?
Like most passively managed funds, ETFs also follow an index or a specific sector. Here is how they work: ETFs, like other funds, pool together money from various investors into a common basket. This basket is likely to hold different types of investments including stocks, bonds, commodities and other securities.
By spreading the fund’s money into different securities, and by investing in a wide range of companies, ETFs have in general proved to be a good way to provide investors with diversification and thereby help balance out risk.
Different types of ETFs
There are quite a few different types of ETFs to find at the stock exchange. Let’s look at a few examples: There are passive ETFs, active ETFs, ETFs based on stocks, ETFs based on bonds, ETFs based on a specific sector, ETF based on currency, commodity ETFs, Inverse ETFs and leveraged ETFs.