Everything you need to know about ETFs

It’s fairly simple and straightforward. A fund provider owns different underlying assets that usually track a specific index or group of products and sells shares to investors. Technically speaking, investors do not own the underlying assets in the fund and instead, own a portion of the ETF. Regardless, they will still receive dividends and are part of other corporate actions indirectly.

 

The beauty of ETFs is that they can be customized to include anything. For example, there exist funds that track precious metals or the stocks of the S&P 500 and even hybrid funds that are multi-asset.

 

ETFs trade at a market-determined price that is usually different from the price of the underlying asset or basket. Also, the long-term performance of an ETF may vary from the index or group of assets it tracks because of associated expenses and other factors.

During 2020, US-listed ETFs experienced an inflow in excess of $500 billion, up from around 50% during 2019. This shows the recent trend in how investors are flocking towards simpler products that offer broad diversification.

Diversification

One of the main and attractive aspects of ETFs is their simplicity and ease in offering a diversified approach to investing. ETFs allow diversification across different assets such as bonds and stocks while also offering access across different industries and sectors. The options are countless and with just a few ETFs, an investor can create a highly diversified portfolio that could go as far as covering thousands of underlying assets within each fund.

 

Transparency

Information on ETFs is present online across major financial news websites as well as the fund provider’s website. Anyone with access to the internet can search for news, pricing, holdings, and other information pertaining to a specific ETF. Mutual Funds are a bit more discreet in terms of revealing information specific to the fund i.e. disclosing holdings monthly or quarterly instead of real-time which is the case for ETFs.

 

Taxes

Investors usually pay taxes only when they sell their ETF while for mutual funds, the need to sell assets to raise cash can include a heavier tax load.

 

Costs

While expense ratios are one thing, the need to pay commissions when trading through an online provider creates another layer of expenses that could affect the overall performance of an investor's portfolio. Nonetheless, most brokers have greatly reduced commissions while others have removed it completely or in favor of a different expense model that is still seen as advantageous for investors.

 

Liquidity

This is an important point to discuss as not all ETFs experience the same money flow or interest from investors. While some funds trade heavily throughout the day, other ETFs may not exhibit the same daily liquidity and could be harder to buy or sell at a certain desired price. Some ETFs may include one or more assets that are deemed desirable to investors while other ETFs may not be as popular.

 

Closure

Some ETFs may face strong money outflows which render the fund unable to cover costs. In this case, the fund is likely to close with investors forced to sell at an undesirable time and price. This is not uncommon and a fund may be invested in assets that have recently faced a sharp price decline, forcing investors to exit their positions.

 

If you’re looking for the simplest approach to investing in a broad range of stocks, certain index ETFs may be right for you. If you’re an investor who believes that energy prices are likely to go up over time, there exist Energy ETFs that track a variety of such products. If you’re someone looking to be invested across a broad spectrum of asset classes, you will find plenty of ETFs that are multi-asset or simply invest in a few top-performing ETFs where each one tracks a certain asset class.

 

At the end of the day, it depends on your expectations, investment goals, and risk tolerance as well as how much time and effort you are willing to personally invest in creating the right portfolio. Some people do not have the time for this and prefer owning one broad ETF or a few while others may be invested in dozens of ETFs for ultimate diversification.

 

On a different note, some investors believe in the actively managed approach of mutual funds who are always attempting to outperform the market and sometimes, with good success. This is a good option for the more risk-tolerant investor who wants to try their luck at making bigger returns if they believe a certain fund manager is capable enough.

 

Nowadays, opening a trading account is as easy as filling out a form, submitting verification documents, and funding your account, a process that takes no more than two or three days. For ETFs, it’s no different. You would need to open an account with a trading provider that offers ETFs such as CFI.

 

The best providers to look for are ones with experience, a good name in the industry, dedicated client support, low or zero commissions, and a provider who would go the length to make sure your trading experience is the best it can be.

The below categories are not the only ones available but are seen as the most sought-after types of funds.

While the US is seen as a massive market for ETFs, some of them may be invested in assets available and traded in other countries. For example, some ETFs may invest in stocks across Europe, Asia, or the entire world at once. This also includes other asset classes such as bonds and commodities.

Sector investing is slightly more specific than broader index investing and includes the stocks of a certain sector such as financials or health care. They provide less diversification but could be more lucrative than broad market investing if that sector experiences strong growth.