The Beginner’s Concise Guide to Understanding ETFs

What are ETFs?

ETFs as we all know them are shorts for Exchange-Traded Funds. An ETF is a basket of securities that contains stocks, bonds, securities, and other financial assets. These funds are index funds that can be traded on an exchange just like stocks and bonds.

ETFs were started in the ’90s. At inception, they only tracked market indexes like the S&P 500. About three decades later, there is just about all kinds of ETFs available for almost anything and everything.

Some of these ETFs include:

  • Bond ETFs
  • Market ETFs
  • Sector ETFs
  • Foreign Market ETFs
  • Style ETFs
  • Leveraged ETFs
  • Commodity ETFs

How do ETFs work?

An ETF as opposed to popular opinion does not include all the stocks or bonds in an index. It sometimes contains only a selection of securities in an index picked and managed by a portfolio manager.

ETFs are in some ways similar to mutual funds. It is more accurately a crosslink between mutual funds and stocks.

Just like with a mutual fund, you can buy small bits and units of a portfolio of stock and bonds. 

While you can only buy mutual funds at the day’s market close though, you can buy ETFs during normal market hours like other stocks or commodities.

Are ETFs better than mutual funds?

There’s no absolute metric to weigh a decision on which is better but we can point to one or two advantages that ETFs have over mutual funds.

Flexibility

As was mentioned earlier, ETFs are traded on exchange. Mutual funds on the other hand can only be traded at the close of the market day. This affords ETF investors more trading flexibility than mutual funds.

Transparency

You can know the value of the portfolio you’re holding as opposed to the quarterly release of mutual funds holdings.

As a plus, ETFs are also more tax efficient than mutual funds.

Why ETFs may be a great option for you

If you can’t really afford the time to sit with individual stocks of companies to research them and form a judgement on them, then ETF might be a great option for you. Even if you have the time, you might not have the energy to do so. More so, these things can look so confusing to the untrained eye. You can spare yourself a lot of headache by buying ETFs.

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