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Exchange-Traded Fund – ETF

What Is an ETF?

An exchange-traded fund (ETF) is a collection of securities—such as stocks—that tracks an underlying index. The best-known example is the SPDR S&P 500 ETF (SPY), which tracks the S&P 500 Index. ETFs can contain many types of investments, including stocks, commodities, bonds, or a mixture of investment types. An exchange-traded fund is a marketable security, meaning it has an associated price that allows it to be easily bought and sold.

KEY TAKEAWAYS

  • An exchange-traded fund (ETF) is a basket of securities that trade on an exchange, just like a stock.
  • ETF share prices fluctuate all day as the ETF is bought and sold; this is different from mutual funds that only trade once a day after the market closes.
  • ETFs can contain all types of investments including stocks, commodities, or bonds; some offer U.S. only holdings, while others are international.
  • ETFs offer low expense ratios and fewer broker commissions than buying the stocks individually.

An ETF is called an exchange-traded fund since it’s traded on an exchange just like stocks. The price of an ETF’s shares will change throughout the trading day as the shares are bought and sold on the market. This is unlike mutual funds, which are not traded on an exchange, and trade only once per day after the markets close.

Cash Invested in ETFs

The dollar amount, in trillions, invested in exchange-traded funds worldwide.

An ETF is a type of fund that holds multiple underlaying assets, rather than only one like a stock. Because there are multiple assets within an ETF, they can be a popular choice for diversification.

An ETF can own hundreds or thousands of stocks across various industries, or it could be isolated to one particular industry or sector. Some funds focus on only U.S. offerings, while others have a global outlook. For example, banking-focused ETFs would contain stocks of various banks across the industry.

Types of ETFs

There are various types of ETFs available to investors that can be used for income generation, speculation, price increases, and to hedge or partly offset risk in an investor’s portfolio. Below are several examples of the types of ETFs.

  • Bond ETFs might include government bonds, corporate bonds, and state and local bonds—called municipal bonds.
  • Industry ETFs track a particular industry such as technology, banking, or the oil and gas sector.
  • Commodity ETFs invest in commodities including crude oil or gold.
  • Currency ETFs invest in foreign currencies such as the Euro or Canadian dollar.
  • Invers ETFs attempt to earn gains from stock declines by shorting stocks. Shorting is selling a stock, expecting a decline in value, and repurchasing it at a lower price.

Indexed-Stock ETFs

An indexed-stock ETF provides investors with the diversification of an index fund as well as the ability to sell short, buy on margin, and purchase as little as one share since there are no minimum deposit requirements. However, not all ETFs are equally diversified. Some may contain a heavy concentration in one industry, or a small group of stocks, or assets that are highly correlated to each other.

Dividends and ETFs

While ETFs provide investors with the ability to gain as stock prices rise and fall, they also benefit from companies that pay dividends. Dividends are a portion of earnings allocated or paid by companies to investors for holding their stock. ETF shareholders are entitled to a proportion of the profits, such as earned interest or dividends paid, and may get a residual value in case the fund is liquidated.

ETFs and Taxes

An ETF is more tax efficient than a mutual fund since most buying and selling occurs through an exchange and the ETF sponsor does not need to redeem shares each time an investor wishes to sell, or issue new shares each time an investor wishes to buy. Redeeming shares of a fund can trigger a tax liability so listing the shares on an exchange can keep tax costs lower. In the case of a mutual fund, each time an investor sells their shares they sell it back to the fund and incur a tax liability can be created that must be paid by the shareholders of the fund.

 

 

 

Take a look at our analyzes in the ETFs Report to find out what we think are the best ETFs to keep in one Portfolio, for good diversification of your portfolio.

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