What Is an ETF?
An Exchange Traded Fund (ETF) is a type of security that holds small proportions of other securities, like equities, that often track an underlying index. ETFs are in many ways like mutual funds; however, ETFs are traded throughout the day and listed on exchanges all over the world. ETFs cannot be invested via a systematic purchase like mutual funds can for this reason. Since ETFs are traded throughout the day like ordinary stocks, they are more liquid than a mutual fund – the market must close to fill a mutual fund order. ETFs can contain many different securities including stocks, commodities, bonds, or a mixture of investment vehicles.
Types of ETFs
There are many uses for ETFs. Income generation, speculation, hedging against inflation, and mitigation of risk are all ways that ETFs can fill a role in a diversified portfolio. Here are a few examples of varieties of ETFs and what they may hold:
Bond ETFs – may include government, corporate, state, and municipal bonds
Industry/Sector ETFs – utilized to track a particular sector or industry such as technology, home goods, banking, alternative energy, or others. If an investor feels strongly about a particular niche within the overall market this can be used to capitalize on that ideology
Commodity ETFs – invest in commodities such as grains, gold, beef, or natural gas
Currency ETFs – invest in foreign currencies such as the Euro or the Japanese Yen
Inverse ETFs – attempt to earn gains from stock declines by short selling stocks, this is a common way investors use ETFs to hedge against market movement
Pros and Cons of ETFs
Pros: Access to many stocks across various industries, low expense ratios and fewer broker commissions, risk management through diversification, ETFs that focus on targeted industries, and ETFs are more liquid than mutual funds.
Cons: Actively managed ETFs have higher fees and single-industry focus ETFs limit diversification
How to Buy and Sell ETFs
ETFs trade through online brokers and traditional broker-dealers. They may be purchased through any online brokerage account, or through a financial advisor.