A Beginners Guide To Smart Investment Through Exchange-Traded Funds (ETF)

Are you looking for simplified stock trading but also acquiring the diversified perks of mutual funds? Wait no more, ETFs combine both investment instruments for you to maximize profits. Exchange-traded funds (ETFs) are types of investment funds that provide the best elements of two assets. ETFs offer diversification of mutual funds and eased out the procedure of stock trading. Sounds interesting? We will discuss all the attributes and benefits of ETFs.

ETFs track a particular sector, index, commodity, or other assets, unlike mutual funds investors can purchase ETFs on exchange stock similar to trading stocks. From the price of an individual commodity to or large and diverse collection of securities, ETFs are structured to track different aspects of your investments. Additionally, ETFs can be used to monitor specific kinds of investment strategies. 

One of the initial ETFs was SPDR S&P 500 ETF (SPY), which aids in tracking the S&P 500 index and is known to be one of the active ETFs today. 

Do you want to explore more on understanding ETFs? This blog is designed to simplify your investment journey by offering you an expert's guide and gaining a varied investment perspective. Let us walk you through to different factors of ETFs to solve your concerns like what is an ETF investment? What are ETFs and how does it work?

• What is ETF investment?
• What is ETF investing and how does it work? 
• Factors to consider while investing in ETF
• Cost of ETFs
• ETF vs Mutual Funds
• ETF vs Stocks
• Online brokers vs traditional brokers
• How to find the right ETFs?
• Types of ETFs
• How can I invest in ETFs
• Bottom line

What is ETF investment?

An exchange-traded fund or ETF, combines varied investment instruments like stocks, bonds, mutual funds, and other assets. One of the highlighting benefits of ETFs includes that it allows investors to access or invest in multiple securities all at once. Additionally, ETFs have lower fees compared to other types of funds, and ETFs can be traded easily by anyone. 

Though, like other financial products, ETFs are not an all-in-one solution for everyone. Investors need to analyze ETFs based on their merits, involving commission and management fees - if applicable. Furthermore, understand how easily you can buy or sell ETFs, and how these investment vehicles fit into your portfolio considering their investment quality. 

What is ETF investing and how does it work? 

While the benefits of ETFs can aid investors to lead a simplified trading journey, this investment source can be confusing and beginners often have concerns about how an ETF works. Stay with us, here’s how it works. 

The fund provider owns the underlying assets, then they would design a fund to track the performance and sell that fund to the investors. Shareholders can own the ETF funds, however, they cannot have access to the underlying assets of their funds. Even if investors in an ETF tracks a stock index, may receive dividends or retirement lump sum payment ( for stock that makes to the index). 

ETFs are designed catering to track the value of an asset or index, whether it is a commodity like gold or a combination of multiple stocks like the S&P 500 which are traded at market prices that usually differ from the asset. What’s next? Expenses and long-term returns of ETFs typically vary from the underlying assets. 

Confused? Let’s understand how an ETF works with more clarity. 

• An ETF provider facilitates a basket of ETF assets like stocks, bonds, commodities, or even currencies and creates a combination of them with a ticker represented in a stock. 
• Investors can buy a combination of ETF funds similar to buying multiple shares from a company. 
• Buyers and sellers can seamlessly trade on the exchange throughout the day just like stocks. 

Factors to Consider while Investing in ETF

Just like trading stocks, even with an ETF investors need to open a brokerage account to initiate investment. Before you begin investing in an ETF, you will need to fund your account, the method to fund the account relies on your broker. 

After completing the step of funding your account, you can kick start searching for ETFs and make purchases or sell similar to the stocks. One of the ideal ways to purchase ETFs is by using screening tools. Many brokers offer these tools as a method of categorizing or selecting the ideal EF from thousands of options. While you utilize this tool to find ETF options, you must be aware of a few terminologies and factors. 

Volume

The trading volume over a certain time allows investors to compare the varied fund’s popularity. The higher the trading volume, the easier it would be for you to trade the fund. 

Expense

The lower the expense ratio, the less of your investment is allocated to administrative costs. Often, investors find it quite tempting and end up searching for the funds that have lower expense ratios, note that sometimes costly ETF funds, especially actively managed funds have robust performance that makes more return than higher fees. 

Performance

Past performance is not the indicator for selecting the ideal future returns for funds, however, it is a common and effective metric so far to compare varied ETFs. 

Holdings

Portfolios that have varied funds, often are categorized in an ETF screening tool. This allows customers or investors to seamlessly compare different holdings for each ETF option. 

Commission

There are many commission-free ETFs, which means they can be traded without a requirement of fees to complete the trade. Though, it is always worth checking out if this has a potential dealbreaker. 

Cost of ETFs

ETFs often have administrative and overhead costs which are covered by investors. These costs are termed expense ratios, representing a small percentage of the investment. The growth in the industry of ETFs is considered based on the expense ratio being lower, this is considered one of the best benefits of ETFs as it makes an affordable investment vehicle. Depending on the type of ETF and investment strategy, ETFs can have a wide range of expense ratios. 

ETF vs Mutual Funds

ETFs have lower fees compared to mutual funds, and this is one of the great benefits of ETFs.

ETFs tend to offer better tax efficiency than mutual funds do. However, investors who invest in mutual funds tend to have better turnover, especially the one that is more actively managed than an ETF, buying and selling such funds can promote better capital gains. When an investor opts for selling mutual funds, the manager will have to raise cash by selling securities, which can bump up your capital gains. Either way, investors will be on the hook with tax advantages. 

Additionally, the two different financial products have varied management structures, active for mutual funds, and passive for ETFs. Though actively managed ETFs too exist. 

ETF vs Stocks

ETFs are created from stocks, but there isn’t anything like ETF stock. You can buy a share of an ETF, but you cannot purchase a stroke in an ETF. Additionally, ETFs are made of individual stocks and other investment vehicles. 

Similar to stocks, investors can trade ETFs on exchange stocks and are represented with tickers as a symbol to allow you to track the price update. ETFs usually represent a combination of varied stocks, unlike stocks which represent shares of a company. Furthermore, ETFs offer more diversification than single stocks as it involves multiple stocks. This diversification can save you from risk factors in your portfolio. 

Sometimes, ETFs are focused on certain themes or sectors. For instance, SPY is one of the ETFs and tracks S&P 500, and there are other fun ETF activities like HACK for cyber-security fund security or FONE for ETF smartphone specifics. 

Read Also:- Stocks Vs Bonds: A Roadmap To Grow Your Wealth Effectively

Let’s have a closer look at the main distinct factors to understand the difference between mutual funds, ETFs, and stocks. 

Distinct factors	ETFs	Mutual Funds	Stocks
How to buy	Traded usually during regular market areas and extended hours	At the end of trading hours, when the market closes	Traded during market hours and extended hours
Fees	Commission fees are often $0, but it can be as high as $5	Average expense ratio includes 0.47% plus additional fees	Commission fees is often $0, but it can be as high as $5

Online Brokers vs Traditional Brokers

ETFs are usually traded by online brokers and even traditional traders. You can consider purchasing ETFs in your retirement account as well. If you are looking for an alternative to standard brokers, you can approach robo-advisors, like Betterment and Wealthfront, which can help you make extensive usage of an ETF through their investment or financial product. 

Talking brokerage accounts, allows investors to trade shares of ETFs just like trading shares of the stocks. Investors with extensive experience may consider traditional brokers as an ideal option. Whereas, investors who desire a passive approach to ETF may opt for robo-advisors. While robo-advisors involve ETFs in the portfolio, the option for choosing an ETF or individual stock would not be asked of investors. 

How to Find the Right ETFs?

The cost for the ETFs are lower, it is important to know that the fees vary from fund to fund, depending on the issuer, complexity, and demand. Even if you choose to track ETfs of the same index, the cost will differ. 

Majority of the ETFs are passively managed investments, tracking an index. Some investors prefer a hand-on approach to mutual funds, run by professional managers who aim to outperform the market. Additionally, there are actively managed ETFs that act like mutual funds but charge higher fees. Consider your investment style before you decide to purchase an ETF. 

The explosion of the market has observed some funds coming to market that may not raise on merit. Borderline funds that take up a minimal portion of investing may not offer you diversification in your portfolio. ETf is affordable, doesn’t mean it will fit your border investments. 

We are listing a few best-performing ETFs

Symbol	Name of Fund	5 Year Return
XSD	SPDR S&P Semiconductor ETF	211.29%
SMH	VanEck Semiconductor ETF	175.90%
TAN	Invesco Solar ETF	216.88%
QCLN	First Trust NASDAQ Clean Edge Green Energy Index Fund	176.54%
SOXX	iShares Semiconductor ETF	169.65%

Types of ETFs

To understand how an ETF works, you will have to be well-versed in the types of ETFs. We are listing below varied types, not that these types aren’t mutually exclusive For example, stock ETF can be index-based, and the types are not categorized by management basis. 

Stock ETFs

These types of stocks are advised to acquire long-term investment goals. It is less risky than individual stock, though it can be a slightly riskier option than other types of ETFs. 

Bond ETF

Bond ETFs do not have any maturity date, one of the common uses of this category is to generate regular cash payments for investors. The payments come from interest generated from the individual bond within the fund. Lastly, Bond ETFs can be low at risk, an excellent option that complements to stock. 

Commodity ETFs

Commodities are the raw goods that can be sold or bought, like gold, crude oil, coffee, etc. Additionally, commodity ETFs combine different securities into a single investment. When you think of investing in commodity ETF, make sure you are aware of whether you get ownership in the fund's physical stockpile commodity or own equity in that produce, and transport these goods. 

Other factors like does this category include future contracts? Is a commodity considered collectible by the IRS? Can arise tax implications and risk levels. 

International ETFs

Foreign or international stocks are preferred widely to build a diversified portfolio, including USA stocks and bonds. This category is considered a less risky and easy way to invest. International ETFs may include investments in individual countries or specific country blocs. 

Leveraged ETFs

Focused on tracing current index funds, but the benefit of Leveraged ETF is rather than matching index funds, it focuses on increasing the funds by 2-3 times. For instance, let’s say you have a traditional ETF followed by the S&P 500. If S&P 500 went up by 2%, your ETF is also likely to increase by 2% because it holds the same companies that track index funds. 

In other cases, if you had leveraged the S&P 500 ETF, a 2% gain could go up to a 4% gain. This can serve as a great benefit of an ETF only if the market is going up. This is the reason why Leveraged ETF is considered riskier. 

Sector ETFs

The American stock market is divided into 11 sectors, each built in a way where companies operate within the sector. This category allows investors to invest in companies from certain sectors like healthcare, finance, technology, or industrial sectors. 

For investors who tend to track the business cycles, Sector ETF can be beneficial as a few sectors perform in the expansion period. Though, this category carries a higher risk than the broader market.

Read Also:- Can You Lose More Than You Invest in Stocks? Here’s The Answer

How can I Invest in ETFs?

Whether you are a beginner or an expert, you must be wondering how an ETF works or how can I invest in an ETF. There are various ways, and how you invest will depend on your preferences and investment style. However, let’s have a look at basic procedures that can help you get started with your ETF investment journey. 

First Open Brokerage Account

As we mentioned above, you will need a brokerage account, to begin with ETF investment. This account is the place where your investment or funds live, though having an account does not mean that you have invested in an ETF. However, you can search for investing in an ETF from this account. 

Find your Ideal ETF to Invest in

There are a lot of ETFs available, while this may sound complicated but you can easily find the right option. To narrow down your ideal ETF, you can use online screeners to finalize low-cost funds, funds from specific sectors, or an ETF that is environmentally focused and socially responsible. 

Purchase ETF

By utilizing a brokerage trading function or tool, you can navigate specific ETFs that you would like to purchase or place the trade. Ensure that you cross-check orders before you buy it officially. 

Holding ETF

Like stocks, holding on to the ETF will depend on your investment strategy and financial goals. However, if you are saving up for retirement it will take a while. Due to the nature of compound interest, the longer you hold on to the ETF you will acquire better interest. 

Additionally, if you have a longer investment time horizon then you will be able to ride through the lows and highs of the stock market as it rises over time. 

Bottom Line

An ETF is a cost-effective method to acquire exposure to gains with accessibility to a broader range of securities and funds within one investment and with a limited budget. Instead of purchasing individual stocks, you can buy shares of the funds of the companies that focus on representing varied sections of the wider market. 

Frequently Asked Questions