What is an ETF?
ETFs, or Exchange Traded Funds, are a more balanced investment option for investors with a lower-risk appetite. They allow investors to put their money into a broad basket of securities in one go, mimicking a hand-picked balanced portfolio. Here’s the lowdown on ETFs.
What is an ETF?
An ETF (Exchange Traded Fund) is what’s known as a “basket of securities.” You can invest in a particular sector, such as energy or tech, or opt for a broad-spectrum ETF that allows you to invest across the stock market. Some ETFs are US-only, while others allow you to invest in different global markets. Regardless, their value is determined by the assets they hold.
Most rookie investors are looking for a simple option with balanced risks. ETFs are a handy way to avoid investing in one asset or stock, which leaves you more vulnerable to losses or having to create your own diverse portfolio. An ETF allows you to make a diverse investment and easily deposit your money in one place. You buy a share of the fund, which pools your money with other investors to make investments.
There are two main types of ETFs: passive and active. Passive ETFs typically track a market index, such as the S&P 500 or FTSE 100, and their performance mirrors what’s happening with these companies or securities. Active ETFs have a fund manager who decides which assets to hold or sell based on market performance.
ETF vs. mutual fund
The main difference between an ETF and a mutual fund is how they’re bought and sold. A mutual fund’s value is set at the end of the trading day and remains the same throughout the next. ETFs, meanwhile, can be bought and sold on the stock exchange in the same way as stocks in individual companies. Their value can go up and down during the trading day. Generally, ETFs have lower fees than similar mutual funds.
ETFs can offer tax advantages compared to mutual funds too. The assets held within mutual funds are traded more often, particularly if the fund is actively managed, leaving you open to a capital gains tax bill. With an ETF, you’ll generally only pay capital gains tax once you sell it rather than throughout the period you hold the investment.
How to invest in an ETF
Before you invest, work out which type of ETF you’re interested in, such as:
Stock ETF – a basket of stocks, which could be in one particular sector or broadly spread across the market.
Bond ETF – based on bonds, such as government bonds or corporate bonds.
Sector ETF – invests in stocks or commodities in a particular sector of your choosing.
Commodity ETF – invests money in physical commodities, such as oil and gold, which can be more accessible than investing outright.
Currency ETF – tracks the performance of currencies across the world.
Leveraged ETF – put simply, this category of ETFs aims to make more than whatever they track. So, if you buy into a 2x leveraged fund that’s tracking an index, which rises in value by one percent, you’ll get a two percent return. You’ll also lose two percent if the index drops by one percent.
Inverse ETF – based on shorting stocks, inverse ETFs make investors money by anticipating market declines. If the market declines, an inverse ETF generally increases in value.
You can buy ETFs through an investment platform like Robinhood, Fidelity, Charles Schwab, or E-Trade. Simply register, and you can begin depositing funds into various ETF options. Some platforms have curated options ideal for rookies, tailored to different risk appetites.
However you choose to invest, ETFs are best approached with a long-term view of your return prospects. An ETF isn't for you if you’re looking for quick returns. But if you’d like to invest for retirement or to start a college fund for your young children, an ETF could be the perfect vehicle for your investment funds.
What are the risks of ETF investing?
Even though the godfather of savvy investments, Warren Buffett, has lauded ETFs as a smart option, no investment is risk-free. Any investment puts you at risk of losing all of your funds, so you should only ever invest amounts you can afford to lose.
For ETFs specifically, the main risks are:
Closure of the fund: if the fund you choose doesn’t attract enough investment to cover admin costs, it may close. You won’t lose your money, but it will mean you have to sell up. If you haven’t held the investment for long, you may have to chalk it up as a loss.
Liquidity issues: choosing an ETF that isn’t traded daily can make it harder to sell up. This won’t be an issue if you’re saving for a long-term goal, but it’s not ideal if you may need the money at short notice. If you’d like to keep your investment pretty liquid, go for an ETF that’s regularly traded.
Slower returns: ETFs generally won’t make you a quick buck, and depending on market conditions, your investment may take a while to make any notable gains. If you’re investing for something in the near future, like a house purchase or imminent retirement, ETFs may not be a good fit.
While not a risk, it’s also important to consider the fees and expense ratio when exploring your ETF options. ETFs are considered to have lower fees than some investment options, as they’re typically curated they do not need ongoing active management. If you choose the DIY route to investing, each platform will have different fees. Make sure you carefully scrutinize them before deciding on the best option.
The most popular ETFs
The first ETF, the SPDR S&P 500 (SPY), is still a popular option for risk-averse investors. It generates returns based on the S&P 500 index, which tracks the performance of some of the market’s biggest companies. While the best ETFs will change regularly, some solid options include:
iShares Core S&P 500 ETF (EVV)
Invesco QQQ (QQQ), which tracks the Nasdaq 100 Index
Vanguard S&P 500 ETF (VOO)
If you lack the confidence to invest independently, why not speak to a trusted advisor about your investment prospects? They’ll help you assess the market and find the best option for your financial goals and risk appetite. Find an advisor today with Unbiased.
Senior Content Writer
Rachel is a Senior Content Writer at Unbiased. She has nearly a decade of experience writing and producing content across a range of different sectors.