An exchange-traded fund, commonly referred to as ETF is simply a collection of securities that may consist of bonds, stocks, real estate, commodities, and other financial market assets.
Typically, you can buy and sell exchange-traded funds on an exchange the same way you would do with stocks. These assets are designed to offer transparency, liquidity, and a wider range of tax benefits.
Just like any other financial market product, ETF funds are not a one-size-fits-all solution to trading. In fact, successful ETF traders evaluate each component in the basket on its own and its investment quality before making a decision.
In this article, we discuss some of the essential things you need to know about exchange-traded funds.
How does ETF work? Three simple steps
Here is how exchange-traded funds work in three simple steps:
- An ETF provider considers a wide range of financial market assets, including bonds, currencies, stocks, or commodities, and creates a basket/group of them with a unique ticker.
- Investors/traders can buy a share of the basket the same way they would purchase shares of a company.
- Buyers and sellers then trade the ETF throughout the day on an ETF exchange, much like a stock. This is what is referred to as ETF trading and involves fulfilling an ETF price.
What are some of the common types of ETFs?
There are different types of ETFs which vary greatly in terms o their investment goals and underlying assets. Here are some of the common types of ETFs and how they differ. Just keep in mind that these ETFs are not mutually exclusive. For instance, an ETF stock can also be index-based and vice versa.
- Commodity ETFs: Commodities are mostly raw goods that can be bought or sold, such as coffee, oil, and gold. Commodity ETF provides you with an opportunity of bundling these securities into a single investment.
- Stock ETFs: These are the most common type of ETF funds and mainly comprise of stocks. ETF stock is meant for long-term investment and is less risky compared to individual stocks.
- International ETFs: If you are looking to build a diverse portfolio, you might want to consider this option. International ETFs are an easy and less risky way of finding foreign investments.
- Bond ETFs: Unlike individual bonds, ETF bonds don’t have a maturity date and are generally used to generate cash payments to the trader.
Here is why ETF investing might be worthwhile
An exchange-traded fund offers you a relatively easy way to invest in financial markets without having to research the individual companies. You also don’t have to go through the tiring process of constructing a well-balanced investment portfolio.
Not everyone has the time, energy, and ability to so, and an ETF market provides you with a simple way to gain quick access to a well-diversified set of assets.
Also, investors that like researching stocks can greatly benefit from ETF because stock ETFs are the most common. Basically, these assets allow investors to enjoy a wide range of investing benefits without spending a lot of time on research and analysis.