An Exchange-Traded Fund (ETF) is a collective investment security functioning in a similar manner to a mutual fund. Typically, ETFs mirror specific indices, sectors, commodities or other assets. In contrast to mutual funds, ETFs can be bought or sold on a stock exchange, resembling regular stock transactions. Their structures vary, allowing tracking of anything from individual commodity prices to diverse collections of securities or specific investment strategies.
The first ETF was the SPDR S&P 500 ETF (SPY), which follows the S&P 500 Index and remains the most actively traded ETF to date.
Key Points:
- ETFs are like stock-traded baskets of securities.
- ETF share prices fluctuate throughout the trading day, distinct from mutual funds that trade once daily.
- ETFs may comprise various investments such as stocks, commodities, or bonds, with lower expenses and reduced broker commissions.
ETFs are diversified funds holding multiple underlying assets, making them popular for diversification. These assets can range from stocks and commodities to bonds or a mix of investment types. An ETF can encompass hundreds or thousands of stocks across various sectors or focus on a specific industry or sector. The marketable nature of ETFs allows easy buying, selling, and short-selling on exchanges throughout the day, while being cost-effective and liquid.
Types of ETFs:
Bond ETFs
Bond ETFs provide regular income based on underlying bond performance, encompassing government, corporate, and municipal bonds. Unlike the bonds they represent, bond ETFs lack a maturity date and trade at premiums or discounts.
Commodity ETFs
Investing in commodities like crude oil or gold, these ETFs diversify portfolios and are cost-effective compared to physical possession. They provide a hedge during stock market slumps.
Currency ETFs
Tracking currency pairs, these ETFs serve various purposes, including speculation, diversification, hedging against forex market volatility, and even exposure to bitcoin.
Industry/Sector ETFs
Focusing on specific sectors or industries, these ETFs track companies within that sector, allowing investors to capitalize on industry performance without direct ownership of securities.
Inverse ETFs
These attempt to gain from stock declines by shorting stocks, using derivatives to achieve this. Investors should note that some inverse ETFs are exchange-traded notes (ETNs) rather than traditional ETFs.
Leveraged ETFs
Leveraged ETFs aim to return multiples on the underlying investment’s returns, using derivatives. There are also leveraged inverse ETFs, seeking an inverse multiplied return.
Passive and Active ETFs
ETFs are broadly categorized as passive or actively managed. Passive ETFs aim to replicate index performance, while actively managed ETFs involve portfolio managers making decisions about included securities. Actively managed ETFs offer benefits but tend to be more expensive.
Stock ETFs
Stock ETFs track a single industry or sector, providing diversified exposure to high performers and potential growth. They incur lower fees than stock mutual funds and don’t involve direct ownership of securities.