If you’re just getting started in the stock market or have been around for a while, you might’ve heard the term ETF. ETFs function like stocks in that they are a security whose value fluctuates, but how they work behind the price is much different from standard stocks.
What are ETFs?
Put simply, exchange traded funds, or ETFS, are securities that are made up of a bunch of other securities, usually individual stocks. In short, ETFs track the fluctuations in prices of a bunch of different stocks, usually stocks in certain categories like technology, food & beverage, mining, etc.
ETFs trade just like normal stocks on open markets but provide investors a greater level of security and less volatility as compared to singular stock purchases. ETFs are very similar to mutual funds, except that mutual funds aren’t listed on exchanges and ETFs are.
If you want to put your money away into a safe security and diversify your risk, ETFs are the way to go.
Common ETFs are the SPY, or the ETF that tracks the S&P 500 companies all in one security or DIA, an ETF that tracks the Dow Jones Industrial Average. It’s important to note that these ETFs are simply a collection of the companies that these indexes contain and while they track the price movement of each respective index of companies, the ETFs aren’t the indexes themselves, they’re a security.
- ETFs are a group of stocks or securities lumped together into one security.
- Their prices fluctuate just like stocks, but their volatility, or their change in price over a given time, won’t be as extreme as individual stocks
- There’s ETFs for everything, from crude oil to electricity, from food to water.
- ETFs offer up the exposure to a ton of different companies, like Amazon, Tesla, Google, etc., without having to shell out the hefty price of owning each of those stocks individually.
If you want to take a more conservative long term investment strategy, ETFs are likely the best way to go. Owning significant portions of individual company stock can provide greater return, but it goes the other way too, you could end up losing all your investment in a company too. That risk is muted with ETFs.
Now that we’ve gone through the basics of what ETFs are, let’s take a look at the different types of exchange-traded funds.
Types of ETFs
Like we mentioned before, ETFs come in all sorts of shapes and sizes and you can likely find one that covers exactly what you want to invest in.
- Bond ETFs, which are made up of government and corporate bonds.
- Industry ETFs, which track industries like technology, banking or oil and gas.
- Commodity ETFs, which track the prices of crude oil, gold, silver, and other valuable resources.
- Currency ETFs, which track the changes in value of various currencies, like the Euro or US Dollar.
- Inverse ETFs, which gain in value when a group of stocks go down. These ETFs essentially short the underlying stocks, or bet against them, and go up in value inversely to the stocks.
When looking for ETFs on the open market, you should not that many of them are not actually ETFs, but rather exhchange traded notes, or ETNs. While ETFs actually own the underlying stocks, ETNs are just securities issued by banks guaranteed to track the underlying index without actually owning them as part of the ETN. In all actuality, ETNs and ETFs function the same, but when you buy an ETN, just be aware that you’re buying a guarantee from a bank, not the actual securities it tracks.
What are the advantages of ETFs?
ETFs provide investors lower costs to purchase a wide variety of companies. You could buy a technology ETF, hypothetically, for $50, but if you wanted to purchase all of the underlying stocks individually, you might need $10,000. At the end of the day, you’d get the same return rate, but with much less upfront investment to get the exposure to those companies.
Most ETFs have very low expense ratios. ETFs at the end of the day are funds and protfolios that require some sort of attention from bankers, unlike individual stocks. This means that some ETFs can have fees for ownership, but in general, they’re very low. ETFs that track industries will have very low expense ratios because they don’t have to be actively managed. However, if an ETF tracks something like crude oil, it could have high fees as intensive management is needed for the underlying security, in that case, crude oil.
The pros of ETFs are that they:
- Give you access to entire industries, cheaply
- Give you access to companies and large collections of stock with lower cost
- Provide greater risk management to your portfolio as diversification is built-in
The cons of ETF are that they:
- Can have high fees compared to stock ownership
- Can still limit your exposure to the market if you overinvest in one industry
- Don’t have as much liquidity, i.e. there’s not as many people looking to buy them
ETFs are a great first foray into investing for any beginner and can be a great long term way to build wealth. If you want to buy some ETFs or get started in investing, you can do so through Robinhood or WeBull, both free stock trading platforms that will give you free stocks just for signing up! If you follow the link in the description and sign up, you can get a free stock valued anywhere from $12 to $1400!