ETFs is an abbreviation of exchange-traded funds; it refers to a pooled investment security that operates more like mutual funds. An ETF can be sold or purchased on an exchange like regular stocks. Unlike stocks that hold only one asset, an ETF has multiple underlying assets, making it an excellent choice for diversification.
As such, an ETF contains a variety of investments such as stocks, commodities, bonds, and others. A fund in an ETF holds many investment securities categorized into one sector or industry. In ETFs, the prices change throughout the day as shares are sold or bought in the market.
On the other hand, mutual funds are not traded on an exchange. Instead, they are purchased once every day when markets close. The other difference is that ETFs have higher liquidity than mutual funds and are more cost-effective. This article answers the question, What is an ETF? and why is it an attractive new investment trend?
The various types of ETS available
To answer the question of What is an ETF? Let us look at various types of ETFs available to investors, which they can use to generate income when prices rise or offset risks in their portfolios. The main types of ETFs available are;
Active and passive ETFs
Depending on characteristics, ETFs are generally categorized as either active or passively managed. Passive ETF aims to reproduce the performances of a broad index-a hypothetical portfolio of investments. Therefore, passively managed ETFs are designed to keep track of specific baskets in the underlying asset.
The securities comprising passive ETFs do not change so quickly, and the cost of managing them is low compared to active ETFs. The lower management cost of passive ETFs makes them attractive to many investors.
On the other hand, actively managed ETFs do not focus on an index of securities; instead, they have portfolio managers who decide on what to include in a portfolio. Due to flexibility, actively managed ETFs seem more beneficial than passively managed ETFs but are more costly to investors. Examples of actively managed ETFs include; leveraged ETFs, inverse ETFs, bonds, commodity, currency, stock, and sector ETFs.
What is an ETF? and how to begin investing in them?
The ETF trader’s platforms have made investment easy; however, there are a few steps to follow, which include finding a platform to invest in, researching various ETFs, and choosing the timeframe for your investment. Be clear on your purpose for investing and choose a financial instrument or sector that excites you. Also, choose the right strategy for trading.
How to buy ETFs
Don’t be left wondering What is an ETF? You can trade on ETFs through traditional broker-dealers or online brokers. However, it’s essential to research the best traders in the market. It is also possible to buy ETFs directly from your retirement account. A broker allows you to trade ETF shares the same way as stock shares.
The way you fund your account differs depending on the broker you choose. Upon funding your account, search for the ETFs you want to buy and sell the same way you would with stock shares. You can search for ETFs based on volume, performance, expenses, holdings, and commissions.
Some special considerations in ETFs
ETFs indexed stock
Indexed stock provides an investor with diversification and the ability to buy on margin, sell short, and buy as low as one share since no minimum deposit is needed.
Dividends in ETFs
Apart from offering investors an opportunity to benefit as the prices of stocks fall and rise, they also gain when companies pay their dividends. These companies remit a part of their earnings to ETFs as payment for holding their stock.
Taxes in ETFs
ETFs are more tax-friendly than mutual funds. Most of the selling and buying happens through an exchange, and an ETF sponsor does not have to issue new shares whenever an investor wants to buy or redeem when he wishes to sell.
Exchange-traded funds are becoming a crucial investment opportunity for new investors because they are more diversified and charge low fees. ETFs have higher liquidity and provide better management of your investment. There are also tremendous innovations that are happening in this field of investment.