What Is An ETF?

An exchange-traded fund, or ETF, is a collection of securities under a single umbrella that you can buy or sell in a single transaction without having to purchase each individual security separately.

An ETF may be a basket of stocks from a particular sector, such as healthcare or technology. It can also be a collection of bonds in which case it is a bond ETF. Or it can be an assortment of commodities that forms a commodities ETF. In recent years, ETFs have become very popular and these days, you can even create your own combination of stocks to form a motif, that can be bought, like an ETF, for a single low price.

The way ETFs are structured is that the ETF provider creates a fund to own the underlying assets. The fund is set up to track the performance of those assets and shares in the fund are sold to investors.

ETF buyers are called shareholders, and they own a fraction of the ETF, though not the assets held by the ETF. A flow-through system is in place so if dividend paying stocks are held by the ETF, the ETF shareholders receive their respective portions of the dividends.

ETFs are generally traded daily on a stock exchange much like stocks. But unlike stocks, ETFs have ongoing expenses which are used to manage the funds. They typically have lower fees than mutual funds yet enjoy the same benefits of diversification.

The reason ETF fees are lower is that ETFs are passively managed whereas mutual funds are actively managed. An ETF simply has the goal to track a benchmark, say the S&P 500, whereas mutual fund managers often seek to beat benchmarks, and are paid a higher amount for so doing.

ETF Fees

ETF fees are primarily made up of expense ratios charged at the fund level, but ETF shareholders are generally charged commissions costs when buying and selling in a brokerage account. Vanguard and Schwab are among the leading firms offering wide selections of commission-free exchange-traded funds.

Exchange-traded funds have gained in popularity compared to higher cost mutual funds. The higher costs of mutual funds, which are actively managed compared to passively managed ETF funds, are largely attributable to higher expense ratios. ETF fees are on average about 70% lower than mutual fund fees.

However, don’t be fooled into thinking that lower average ETF fees means all ETFs have low fees. ETF fees can vary widely, though most of the large issuers, such as Vanguard, SPDR and iShares, charge industry-standard fees.

ETFs that track an index may be more easily managed than say an ETF tracking a foreign market, and so higher ETF fees will reflect higher management complexity.

As ETFs become more popular, they gain more assets under management and the percentage fees charged tends to decrease accordingly because fixed costs can be covered more easily.

If you are comparing fees of different issuers, the place to begin is usually Vanguard, which has a reputation as a low-cost fund provider.

When you purchase an ETF, you will most likely pay a commission charge. However, Vanguard makes available over 50 commission-free exchange-traded funds to brokerage clients. Schwab has an even greater selection, and provides brokerage clients with over 200 commission-free exchange traded funds.

ETFs To Buy

When interest rates are rising, confidence in government is falling, currencies are fluctuating, and markets are falling, ETFs can be excellent vehicles to hedge risk and make money trading current trends.

If you are buying ETFs as part of an employer-sponsored plan, you will be limited to the selection range provided by your plan provider. An easy way to compare the quality of ETF funds in your 401(k) plan is to let Blooom compare, analyze and manage funds to ensure lower-fee funds are selected and higher-fee funds are replaced.

BLOOOM SPOTLIGHT
InvestorMint Rating 1 2 3 4 5 4 out of 5 stars	Management Fee: $95 - $250 Account Minimum: $0 Get Started via Blooom secure site

On the other hand, if you have a brokerage account, your selection range of ETFs will be much broader. ETFs allow you to build a diversified portfolio inexpensively, but which ETFs should you select?

The most important first step in selecting ETFs to buy is to find low-fee ETFs because the difference of an additional 0.5% in fees over a 30 year period when starting with a $100,000 can amount to hundreds of thousands of dollars of opportunity cost.

When markets are falling, you can explore one of the many inverse ETFs listed later on in this article. These ETFs can act as a hedge when your portfolio is moving in line with the rest of the market.

When interest rates are rising, bond ETFs that include TIPS that keep pace with inflation are worthy of consideration so that you don’t lose purchasing power over time.

Currency ETFs are also a good hedge against currency risk. For example, if you own some foreign stocks or funds, and want to hedge against swings in the local currency, you can do so by buying a currency ETF.

When confidence in governments declines, commodities, such as gold and other precious metals, rise in popularity. ETFs to buy in the commodities space range from gold and silver ETFs to broader based precious-metals ETFs.

Investors with higher risk tolerances may find small cap ETFs to buy that provide opportunities for larger gains than the general market while lowering the risk of holding a single stock position, such as a penny stock. If you prefer to purchase penny stocks, the best penny stock brokers generally have flat commission structures.

Risk-averse investors will find a wide selection of attractive ETFs to buy, including large cap ETFs, investment grade corporate bond ETFs, index ETFs, as well as sector ETFs and industry ETFs that offer exposure to the healthcare industry, technology industry, and energy sector among others.

Whichever ETF you choose, you should generally find it is easy to identify the fees charged and assets held by the fund. Plus, a benefit over mutual funds is the tax treatment tends to be better because taxes are due when selling – as opposed to mutual funds which often result in tax liabilities even when still holding the fund.

Advertisement

Banking Nightmare

During and after the Great Financial Crisis of 2008, 485 U.S. banks went under. Here at Weiss Ratings, we warned about 484 — an accuracy rate of 99.8%. Now, we have a new warning. But this time, it's not just about a few hundred banks … it's about nearly every single bank in America …

Get all the details here

ETF Investing Risks

Investors looking to beat market benchmarks should consider alternatives to ETFs, which are designed to track but not outperform benchmarks. Unless the ETFs are commission-free, churning an account by buying and selling frequently can hurt portfolio value.

When you purchase an ETF, the fund is passively managed and designed to mirror the performance of a benchmark. If you are striving to beat the market, then a mutual fund or individual stock purchases may be a better bet.

Frequent traders should also be aware of the risks of churning accounts, which takes place when buying and selling securities regularly and paying commissions each time. These transaction costs can add up in a hurry and eat away at performance gains.

ETFs may have lower administrative and management costs than mutual funds, but they still require a large amount of assets under management to make them profitable. If you find an ETF that has not been trading long and has few assets under management, it may be worth treading carefully because if the fund closes, you will be forced to sell sooner than you may wish.

>> Discover The Best Brokers For Free Stock Trading

➤ Free Guide: 5 Ways To Automate Your Retirement

Types of ETFs

Popular exchange-traded funds include Index ETFs, Foreign ETFs, Currency ETFs, Sector ETFs, Industry ETFs, Inverse ETFs, Commodity ETFs, Market Cap ETFs, Bond ETFs and Exchange-traded Notes.

A vast array of exchange-traded funds have been created to meet the needs of fee-savvy investors. Famed investor, Warren Buffett, advocates that most individuals invest their nest-egg in an index fund, such as the SPY, which is the best known exchange-traded fund that tracks the S&P 500.

INDEX ETFs

An ETF is designed to emulate the performance of an index, not produce superior returns. In the US, some popular ETFs include:

FOREIGN MARKET ETFs

Foreign market ETFs are a simple way to get exposure to international markets. If you are looking for exposure to developing markets or developed markets, there is almost certainly a foreign market ETF to meet your needs.

Some of the most popular foreign market ETFs include:

CURRENCY ETFs

If you are looking to track a foreign currency but don’t want the volatility and leverage associated with trading Forex markets directly, a currency ETF can provide you exposure to a foreign currency or even a basket of foreign currencies.

Currency ETFs include:

SECTOR ETFs & INDUSTRY ETFs

Sector ETFs and industry ETFs are an inexpensive way to get exposure to broad baskets of stocks in a certain sector or industry. These ETFs allow for better diversification than buying specific stocks alone.

>> What are the best stocks to buy?

INVERSE ETFs

Betting against the market can be lucrative at times, especially when economies are weakening and markets moving lower. There are lots of ways to make money from a declining market, such as shorting stock and buying put options. Another way is to buy an inverse ETF that goes up when the market goes down.

COMMODITY ETFs

As confidence in governments fluctuates, the popularity of commodities ebbs and flows. To gain exposure to gold, silver, and other commodities, without having to buy the underlying physical commodity, ETFs offer an easy and viable alternative.

Popular commodity ETFs include:

MARKET CAP ETFs

If you want exposure to small cap stocks, mid-cap stocks, large cap stocks or a composite of value style, growth style or blend style funds, exchange-traded funds have been built to meet your investing goals.

Small cap ETFs track companies with market capitalizations under $1 billion while mid-cap ETFs track companies with market capitalizations from $1 billion to $10 billion. Companies with market capitalizations over $10 billion are considered to be large caps.

Examples of small cap ETFs, mid-cap ETFs, large cap ETFs, value ETFs, growth ETFs and blend ETFs include:

>> Looking to buy penny stocks, view the best penny stock brokers

BOND ETFs

Bond ETFs can be used to bet on interest rate directions, hedge against inflation and gain international exposure. Lots of bond ETFs exist to allow you gain exposure over different time durations, enjoy tax advantages at the municipal level (one of the best municipal bond ETFs is symbol MUB) and earn a return from corporate debt issuances.

EXCHANGE TRADED NOTES

Exchange-traded notes are not the same as exchange-traded funds, but are often confused with them.

Exchange-traded notes, or ETNs, are issued by banks with high credit ratings as senior debt notes. When you purchase an ETN, you are buying a debt instrument similar to a bond.

>> Prefer Hands-Off Investing, Discover The Best Robo-Advisors

>> Is This The Best Stock Market App For Free ETF Trading?

>> You Might Also Like This Article: 51 Crude Oil ETFs and ETNs

Advertisement

Leaked tax return reveals secret to pocketing $460,164...

Official tax return reveals how one trader nabbed annual gains of 228%, 309% and 339%. His tax return was released online, exposing this simple trading technique used to pocket nearly half a million in profits.

Click here to see the official tax return before it is deleted...