If you’re interested in investing in the stock market, you have a number of trading avenues open to you. ETFs are a popular trading technique that may serve your overall strategy well, but what are ETFs?
Some traders may prefer to buy and sell their stocks individually, either tracking their performance minute by minute or taking a positional trading stance and leaving them alone for weeks, months or years. Alternatively, some people prefer to invest across a broad spectrum of stocks simultaneously. Stockbrokers offer various solutions in these cases. ETFs is one of these options, and it has lots of advantages.
ETF Stocks Explained
ETFs (“exchange-traded funds”) are a relatively new type of investment, beginning in 1993. As of 2021, they have reached an estimated value of nearly 6 trillion dollars. ETFs are, in essence, a collection of assets purchased on the stock exchange via a stockbroker. An ETF is similar to a mutual fund, but it sets itself apart mainly by using the exchange to make trades. ETFs, therefore, follow the various stock exchanges’ trading hours. As a result of trading on exchanges, ETFs have the advantage of being able to trade throughout the day, whereas many mutual funds are not publicly-traded, while others could be bought and sold only at their closing price on a given day.
As with US mutual funds, US ETFs are also regulated by the same bodies and must comply with the 1940 Company Act. Further similarities to mutual funds include the need for brokers to regularly communicate the state of the portfolio and set out all financial expenses and investment methods they plan to undertake. The portfolios may also hold not just a handful but potentially thousands of assets. Similar to mutual funds, ETFs can track indexes (the top-performing stocks in a sector), increasing the fund’s flexibility, reducing costs, and allowing investors to get daily (instead of quarterly) progress reports.
ETF Investments Explained
Exchange-traded funds are large portfolios selected and managed by institutional investors, which individuals can invest in. These portfolios can follow or “track” a wide variety of related financial fields. As mentioned, ETFs can mirror indexes in what is generally perceived as a low risk but low-profit technique. They can track a particular market sector, such as energy, healthcare, technology, real estate, financials, utilities, etc. Alternatively, ETFs can attach themselves to any selection of commodities or stocks (“stock exchange-traded funds”). They can also choose whether to bet on or against a sector, meaning the ETF would profit when their overall selection of stocks decreases in value.
What Are The Different Types of ETFs?
There are many different types of exchange-traded funds. ETFs are easy to buy and facilitate access to a wide range of investments, making them an attractive option for traders across the board. These cross-industry funds can be found in various categories, including commodity ETFs, broad-market ETFs, and currency ETFs. To categorically list every possible exchange-traded fund could fill pages (and send you into a spin). That said, if you want to get into ETFs, here are some of the most popular options to consider adding to your portfolio:
If you want access to a basket of securities across diverse corners of the market, look into fixed-income securities. Similar to equity ETFs, these funds are effectively a basket of bonds. There are four areas of fixed-income funds: broad-market, sovereign, corporate, and municipals. Many traders will invest in fixed-income ETFs to reduce the volatility of their portfolios.
For ETF traders who wish to invest in stocks or equities instead of bonds, equity funds are the way forward. This type of ETF effectively bundles together a batch of equities that you can then buy or sell on the stock market in real-time.
Imagine this scenario: the US dollar is depreciating, and this will harm your currency portfolio. You could purchase foreign currency ETFs to protect your investment. By providing you with exposure to forex pairs, currency ETFs are an easy way to diversify your portfolio and protect you from market volatility.
Commodity ETFs are a way to invest in physical goods. Traders can then look for returns in markets other than the stock market. Some investors will use futures or derivatives to gain exposure to commodities. Alternatively, you could purchase shares of the physical goods themselves. By trading in another market (agriculture, energy, etc.) through commodity ETFs you both hedge your portfolio against risk and open yourself to returns from various industries.
Like it says on the tin, bond ETFs exclusively invest in bonds. Essentially, you will have a portfolio of bonds that you can then trade on the stock exchange. Broad-market ETFs give you exposure to the market as a whole. You also get sector-specific ETFs, such as corporate debt, treasury bonds, or you could even invest in the sovereign bonds of foreign nations.
ETF Trading Advantages
Since the first exchange-traded fund was launched in 1993, they have become an increasingly popular investment strategy. ETFs are low-cost, tax-efficient, and immediately diversify your portfolio, making them attractive to all types of investors. Here are a few more advantages to trading exchange-traded funds, they are:
Easy: Each ETF is effectively a mini-portfolio of partial shares assumed in a single transaction. This simplicity – saving you all the time and effort of placing multiple orders – makes them highly appealing to beginner traders.
Liquid: Exchange-traded funds operate just like equities on the stock market. ETFs trade throughout market hours, so you can open and close positions as much as you want.
Low-management: Some ETFs are traded actively, but for the most part, they are passively managed. Therefore ETFs are a relatively hands-free and low-risk option (as opposed to a mutual fund trying to outperform the market). The fact that ETFs require less active management also results in fewer fees making them more cost-effective than mutual funds.
Tax-friendly: Again, because mutual funds tend to be more actively traded, they create more capital gains tax than ETFs. As a mutual fund holder, you may have to pay all the capital gains tax accrued over the tax year in one lump sum. On the other hand, ETFs you choose when you pay capital gains tax because you only pay it when the asset is sold. (Although remember there are other taxes to consider when trading ETFs.)
How Do You Buy Exchange-Traded Funds?
Before you can start trading ETFs, you will need to find a suitable broker. Bear in mind that while exchange-traded funds are low-cost, you have to weigh up the fees of your investment platform. Look for an online broker that offers low to zero commission and with no hidden fees.