What is an ETF?
An exchange-traded fund (ETF) is collective investment security that works similarly to a mutual fund. ETFs often track a certain index, sector, commodity, or another asset, but unlike mutual funds, they are to be bought and sold on a stock exchange just like any other stock. An ETF can track anything from the price of a single commodity to a large and diverse group of securities.
The price of an ETF’s shares will fluctuate during the trading day as shares are bought and sold on the market. This is in contrast to mutual funds, which are not traded on a stock exchange and only trade once a day after the markets shut. Furthermore, compared to mutual funds, ETFs are more cost-effective and liquid.
Types of ETF
Investors can choose from a wide range of ETFs to produce income, speculate on price increases, can partially offset or manage risk in their portfolios. Here’s a look at some of the most popular exchange-traded funds.
1. Passive and Active ETFs
ETFs are classified as either passively managed or actively managed. Passive ETFs are designed to mimic the performance of a broader index, such as the S& P 500, or a more specialized targeted industry or trend.
Portfolio managers decide which stocks to include in an actively managed ETF’s portfolio rather than an index of securities. These funds offer advantages over passive ETFs, but they are more costly to investors.
2. Leveraged ETFs
A leveraged ETF tries to outperform its underlying investments by a factor of several. Inverse ETFs that aim for an inverse multiplied return is also available.
3. Stock ETFs
ETFs that track a single industry or sector are called stock (equity) ETFs. For example, a stock ETF may track automotive or foreign companies. The purpose is to expose students to a variety of industries, including both high-performing organizations and newcomers with development potential. Stock ETFs are less expensive than stock mutual funds and do not require actual stock ownership.
4. Commodity ETFs
Commodity ETFs invest in commodities such as crude oil or gold, as their name suggests. They start by diversifying a portfolio to make it easier to protect against market declines. Commodity ETFs may act as a safety net in the event of a stock market downturn. Second, investing in a commodity ETF is less expensive than investing in the commodity itself. This is because the former does not necessitate insurance or storage.
5. Inverse ETFs
Inverse ETFs try to profit from stock falls by shorting equities. It means selling it and repurchasing it at a cheaper price, anticipating a price drop. To short a stock, an inverse ETF uses derivatives. They essentially wager on the market falling. When the market falls, the value of an inverse ETF rises in proportion.
6. Bond ETFs
The majority of financial experts advise investing a portion of your portfolio in fixed-income products like bonds and bond ETFs. This is because bonds tend to lower portfolio volatility while also offering a source of additional income. Bond funds, like equity funds, come in a variety of options.
7. Currency ETFs
ETFs (exchange-traded funds) track the performance of currency pairs that include both domestic and foreign currencies. Currency ETFs can be used for a variety of purposes. They can be used to speculate on currency prices depending on political and economic trends in a particular country. Importers and exporters use them to diversify their portfolios and protect against FX market volatility. Some of them are also used to protect against inflation. Bitcoin is even available as an ETF.
8. Industry/Sector ETFs
ETFs that focus on a single industry or sector is known as industry or sector ETFs. An energy sector ETF, for example, will own companies in that industry. Industry ETFs monitor the performance of companies in a given industry to provide exposure to the sector’s upside. ETFs do not require direct stock ownership, and the risk of erratic stock performance is reduced. Industry ETFs are also used to move in and out of sectors during economic cycles.
Benefits of ETF
ETFs (exchange-traded funds) have various advantages over traditional mutual funds.
ETFs are similar to popular indexes in that they own all of the securities in the index and provide more diversity than mutual funds. Passive fund management involves fewer transactions than actively managed funds, which buy and sell securities from their portfolio on a regular basis in order to outperform their benchmark. Because actively managed mutual funds must pay STT and capital gains tax when purchasing or selling shares in their portfolio, this churn results in higher tax incidence. As a result, ETFs are fewer taxes than conventional mutual funds.
ETFs also offer a lower expense ratio than actively managed mutual funds, which are required to hire highly trained fund managers in order to generate active returns or returns that are higher than their benchmark index.
ETFs are basically listed on exchanges and traded like stocks, they provide investors with increased convenience and liquidity. Unlike actively managed mutual funds, where the NAV is computed only once a day after the market closes, investors can trade ETF funds at any time during market hours at real-time pricing. ETFs are hands down the best place to start if you’re new to equity investing.