What is an ETF?

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A balanced portfolio starts with diversification, and one of the simplest, most cost-effective ways to achieve it is through exchange-traded funds.

An ETF holds a diverse basket of securities and trades on an exchange throughout the day, just like a stock. Its intraday liquidity is one of its key advantages over mutual funds, which only change price at the end of each trading day.

In this guide, we’ll break down how ETFs work, the different types of funds you can buy, and how they can become a meaningful part of your long-term investment strategy.

How Do ETFs Work?

Most ETFs track the performance of a specific market index such as the S&P 500, and their prices go up and down throughout the trading day, based on market activity. Because they typically hold many securities, they naturally spread risk and provide built-in diversification.

An ETF charges an expense ratio that covers management costs. Passive ETFs, which simply track an index, tend to have much lower expense ratios than actively managed funds. 

The majority of ETFs you’ll come across are registered with the Securities and Exchange Commission, which gives investors an extra layer of assurance. 

The SPDR S&P 500 ETF Trust, launched in 1993, was the first ETF in the United States and is among the largest, with more than $696 billion in assets under management. It tracks the S&P 500, providing exposure to the 500 biggest companies in the United States. 

The Invesco QQQ Trust tracks the NASDAQ-100 and is more concentrated, with a quarter of its holdings allocated to three technology companies: Nvidia, Microsoft, and Apple. This concentration can amplify both risk and potential return.

Types of ETFs

• Passive ETF: This type of fund mirrors a broad index such as the S&P 500 and typically offers low fees because its holdings don’t often change.
• Actively Managed ETF: In this type of fund, managers select, reassess and reshuffle securities rather than simply tracking an index, which can result in higher fees.
• Bond ETF: They invest in government, corporate, municipal, or state-issued bonds and provide regular income.
• Dividend ETF: This type of fund focuses on companies with strong and consistent dividend payments.
• Real Estate ETF: Invests in real estate investment trusts that own income-producing properties.
• Sector ETF: These funds target a specific industry such as technology, healthcare, energy or consumer goods.
• Currency ETF: Tracks the value of one or more currencies including the U.S. dollar, the euro or the Japanese Yen.
• Commodity ETF: Provides exposure to commodities like gold, silver, oil or minerals.
• Spot Bitcoin ETF: This type of fund directly owns the cryptocurrency Bitcoin for investors without needing a crypto wallet.

Why Should You Invest in ETFs?

• Their high liquidity enables investors to make quick market decisions.
• Broad exposure across sectors and asset classes provides built-in diversification.
• They generally have lower fees compared to mutual funds.
• Investors can target specific markets, themes, or industries.

Drawbacks of Investing in ETFs

• While often low, expense ratios can bite into overall returns.
• Because they trade like stocks, ETFs’ prices can fluctuate throughout the day resulting in significant losses during a market downturn.
• Investors should be aware that sector ETFs may offer limited diversification.
• During periods of market stress, ETFs may come with liquidity risks.

Where to Buy ETFs

You can buy ETFs through most online brokerages or within your retirement account. Many brokers—such as Vanguard, Fidelity and Charles Schwab—offer a wide selection of commission-free ETFs. Since fees and service levels vary, do your research and pick a brokerage that aligns with your overall financial plan.

Once you’re opened and funded your account, the next step is to search for potential ETF candidates, research them, using tools like fund screeners available from most brokerages, and place your trade.

ETFs: Your Key to Smart Investing

ETFs can provide accessible, flexible, and cost-smart ways to help you build a diversified portfolio. Whether you’re a beginner or an experienced investor, they’re one of the most efficient investment tools available.

Questions and Answers

The post What is an ETF? by Vandita Jadeja appeared first on Benzinga. Visit Benzinga to get more great content like this.