An exchange-traded fund (ETF) is traded on stock exchanges, much like stocks. They hold assets such as stocks, commodities, or bonds and generally operate with an arbitrage device designed to allow it to trade close to its net asset value, although deviations occasionally occur.
ETF prices fluctuate throughout the day as they are bought and sold. Some ETFs trade at a premium or discount to their net asset value. The value of an ETF’s shares is determined by the market supply and demand for the shares.
An ETF owns the underlying assets (shares of stock, bonds, oil futures, gold bars, foreign currency, etc.) and divides ownership of those assets into shares. It trades on an exchange like a stock.
The critical difference between an ETF and a mutual fund or index fund is that an ETF can be traded throughout the day like a stock, while mutual funds and index funds are only priced once per day after the markets close.
Diversification
An ETF offers investors exposure to many assets in a single fund, which can help diversify investment portfolios. For example, the SPDR S&P 500 ETF (SPY) provides exposure to 500 of the largest U.S. companies by market capitalisation.
Low Expenses
ETFs typically have lower expense ratios than actively-managed mutual funds. The expense ratio is the annual fee that all funds and ETFs charge their shareholders to pay for the fund’s operating expenses.
Tax Efficiency
ETFs are generally more tax-efficient than mutual funds because they generate minor capital gains. When a mutual fund manager sells security with increased value, the fund realises a capital gain, which is then distributed to shareholders and taxed at the shareholder’s tax rate. ETFs tend to have lower turnover rates than mutual funds, which means they realise fewer capital gains.
Trading Flexibility
ETFs can be traded on a stock exchange throughout the day, while mutual funds can only be bought or sold after the markets close. It provides investors with more flexibility when it comes to trading.
Access to Hard-to-Reach Asset Classes
Investors can access asset classes that are otherwise difficult to invest in when inventing with ETFs. For example, the SPDR Gold Trust (GLD) provides investors with exposure to gold without owning any physical gold bars.
Risks of trading ETFs
Market Risk
All investments are subject to market risk, which is the chance that the price of an investment will go up or down. ETFs are no different. The value of an ETF’s shares can rise or fall depending on the performance of the underlying assets.
Liquidity Risk
Liquidity risk is when a trader cannot sell a security quickly enough at a fair price. It can be a problem for ETFs because they are traded on stock exchanges and can be subject to significant price swings due to supply and demand.
Geopolitical Risk
Geopolitical risk is the risk that political or economic events will adversely affect the price of your ETF investment. ETFs exposed to international markets are particularly susceptible to this type of risk.
Interest Rate Risk
Interest rate risk is the risk that a change in interest rates will adversely affect the price of an investment. It is a risk for ETFs because they often hold fixed-income securities, such as bonds, which are sensitive to changes in interest rates.
How to invest in ETFs
Decide what type of ETF you want to invest in
Many different ETFs are available, so choosing the one that best suits your investment objectives is essential.
Consider the risks and rewards associated with ETFs
Before investing in an ETF, it’s essential to understand the risks and rewards associated with this type of investment.
Choose an ETF provider
Once you’ve decided what type of ETF you want to invest in, you’ll need to choose a provider. Many different providers are offering a wide range of ETFs.
Open an account with your chosen provider
Most providers will require you to open an account before you can trade or invest in their ETFs.
Start trading or investing in ETFs
Once you’ve opened an account, you can start buying and selling ETFs. You can choose several ETFs, and most providers will offer at least a few.
