Exchange-Traded Fund (ETF)

What is an ETF?

An exchange-traded fund (simply referred to as ETF) is an investment vehicle that is comprised of a collection of assets like stocks or bonds and is traded on an exchange. A mutual fund and an ETF are similar in that they are both investment pools. However, ETF shares are traded throughout the business day on exchanges, akin to stocks.

ETFs are advantageous because they can balance financial risk by investing in numerous securities at once, thus providing a diversified portfolio.

Types of ETFs

Depending on your preference, there are an array of ETFs available to investors. Below are some examples:

Stock ETF

These invest primarily in stocks from a myriad of companies. These investment instruments provide long-term growth and usually carry comparatively less risk than purchasing individual stock in a company.

Index ETF

Designed to track the performance of indexes such as the S&P 500, or the Dow Jones Industrial Average. Most ETFs available on the market are these types of index-based ETFs.

Sector ETF

These invest in securities and track the performance of a specific sector or industry. Because sector ETFs are designed to focus on a specific industry, these obviously provided less diversification.

Bond ETF

These invest solely in bonds, be they government bonds like US Treasuries, corporate bonds, or municipal bonds. An advantage of these specific ETFs is the fact that interest is paid out each month with a dividend, rather than every six months which typically transpires with an individual bond.

Commodity ETF

These are designed to invest in specific commodities such as crude oil, gold, etc. with a single investment.

How do ETFs Work?

Similar to investing in stock, you must invest in shares of an ETF through a brokerage. Once you have researched prospective ETFs and found one that aligns with your investment goals, you then buy shares of it through your broker. Therefore, depending on the particulars of the specific ETF, you could own a stake in hundreds, if not thousands of stocks from a myriad of companies and industries.

Because an ETF is a basket of securities, they require less research than investing in stock from individual companies.

ETFs generate a return for investors by either an increase in the price of the specific ETF, or from dividends. For instance, if the value of stocks within a specific ETF rise, then so does the value of the entire investment instrument.

Say you purchased shares in ETF X for $50 per share. If in 12 months, ETF X is selling for $70 per share, then you gain a $20 per share profit if you choose to sell. Conversely, if the price of ETF X drops in 12 months, then obviously you would experience a capital loss if you choose to sell.

It is crucial to note that NOT all ETFs provide dividends. When researching prospective ETFs to invest in, look for the funds “dividend yield” to see if it pays dividends. This will be a percentage denoting the ratio of the amount paid out compared to the fund’s share price.

Examples of Popular ETFs Available on the Market

Here are examples of some of the most popular ETFs currently available on the market, based on trading volume.

SPDR S&P 500 (SPY) – This is one of the most actively-traded ETFs on Earth because it tracks the S&P 500 Index.

Financial Select Sector SPDR Fund (XLF) – This is the most popular sector ETF based on trading volume, and provides exposure to the financials sector.

iShares Silver Trust (SLV) – This is the most widely-traded commodity ETF on the marketplace and has possession of physical silver bullion.

iShares MSCI Emerging Markets ETF (EEM) – This is one of the oldest and most popular ETFs available to investors. This investment instrument is designed to track the MSCI Emerging Markets Index, which measures the performance of the stock markets of emerging economies.

iShares iBoxx $ High Yield Corporate Bond ETF – This is one of the most popular bond ETFs based on trading volume. This investment instrument was designed to specifically provide exposure to high yield bonds.

ETF Investing Strategies

ETFs have grown in popularity and offer a myriad of choices depending on your investment preferences. Regardless of whether you are more inclined to invest in stock ETFs, bond ETFs, sector ETFs, commodity ETFs, or index ETFs, there are some basic strategies you can implement, be it passive or active investing.

A passive ETF is an investment vehicle that tracks the performance of a specific index like the S&P 500 Index. Passive ETFs basically mirror the performance of the index they are designed to track.

“Buy and hold” is an example of a passive ETF investing strategy, where you buy an ETF (or another security, for that matter) and hold it as a long-term investment.

Conversely, an active ETF is managed by a manager or team of investment professionals with the objective of beating a specific index. Utilizing investment strategies, managers of active ETFs have the potential of outperforming a specific index. Yet, there is also the potential for significant loss should the index plunge.

However, it is important to note that an active ETF has higher fees, as you are basically paying for it to be actively managed by a fund manager. As per the regulations of the Securities and Exchange Commission (SEC), active ETFs are “ are required to publish their holdings daily”.

Ultimately, as an investor, you must research which form of ETF is the best fit depending on your investment goals. Always do your due diligence before making any investment decisions.

Popular ETF Brokers

In order to invest in and trade ETFs, you must first set up an account with a brokerage firm. Because there are numerous brokerages, the choices can be a bit overwhelming, especially for beginners. Here are some of the most popular and respected ETF brokers.

Vanguard ETFs

Vanguard ETFs are a popular choice for investors who want a wide range of professionally managed ETFs designed with different objectives (such as growth versus income). In addition, Vanguard offers commission-free ETFs, meaning the company charges you nothing for trades.

Fidelity ETFs

Fidelity ETFs are another good bet for investors who want a wide range of selection from stock ETFs, bond ETFs, to active equity ETFs. Likewise, you have access to research tools to help assist in your selection. All Fidelity ETFs are commission-free online.

Charles Schwab ETFs

There are over 2,000 Charles Schwab ETFs available across a variety of fund companies and asset classes. Schwab offers $0 commission per trade on ETFs traded online on US exchanges.

ETF Return Calculator

Use this ETF Return Calculator to determine the dividends and growth from an investment in over 2,200 ETFs available on the marketplace. Moreover, this calculator enables you to simulate periodic investments into a specific ETF by day, week, month, or year.

Comparison Table On The Different Types Of Trading

Here is a comparison table examining the different types of trading.

Type of Trading	Best Suitable For	Risk vs. Potential Return	Control Over Investments	Research and Legwork Needed
Options	Active Traders	Lower-level Risk (When Done Correctly)	The investor has complete control over which companies are selected, and what options contracts are chosen.	All research and trading is done by the investor.
Stocks	Beginners and Long-term Investors	High risk, yet has the potential for larger gains	The investor has direct control over all invest decisions.	All research and trading is done by the investor.
ETFs	Beginners and Long-term Investors	Lower-level Risk	Professionally managed investment vehicle.	All research and trading is done by a financial professional. Investors are charged a fee called an "expense ratio".
Bonds	Beginners and Long-term Investors	Lower-level Risk	If investing in individual bonds (rather than bond ETFs) the investor has direct control over all invest decisions.	All research and trading is done by the investor, if investing in individual bonds.
Mutual Funds	Beginners and Long-term Investors	Lower-level Risk	Professionally managed investment vehicle.	All research and trading is done by a financial professional. Investors are charged a fee called an "expense ratio".
Futures	Active Traders	Medium-level risk (when done correctly)	The investor has complete control over which futures contracts are chosen.	All research and trading is done by the investor.
Swing Trading	Active Traders	High risk, yet has the potential for larger gains	The investor has direct control over all invest decisions.	All research and trading is done by the investor.
Day Trading	Active Traders	High risk, yet has the potential for larger gains if done correctly.	The investor has direct control over all invest decisions.	All research and trading is done by the investor.
Commodity Trading	Beginners and Active Traders	High risk, yet has the potential for larger gains	The investor has direct control over all invest decisions.	All research and trading is done by the investor.
Trend Trading	Beginners and Active Traders	High risk, yet has the potential for larger gains	The investor has direct control over all invest decisions.	All research and trading is done by the investor.

Exchange-Traded Fund (ETF) FAQs

How to buy ETFs?

Just like investing in stock, you must invest in shares of an ETF through a brokerage.

Some popular online brokers for investors who are more hands-off include Ellevest, Wealthfront, and SoFi Automated Investing.

For investors who prefer a more hands-on approach, brokers like E*Trade or You Invest by J.P. Morgan may be a better fit for you.

There are also major players like Vanguard, Fidelity, and Charles Schwab that may fulfill your ETF investing goals.

Once you have researched prospective ETFs and found one that aligns with your investment goals, you then buy shares of it through your broker. Therefore, depending on the particulars of the specific ETF, you could own a stake in hundreds, if not thousands of stocks from a myriad of companies and industries.

Because an ETF is a basket of securities, they require less research than investing in stock from individual companies.

What ETFs are available to investors?

There are numerous types of ETFs available on the marketplace, depending on your personal preference and investment goals.

Stock ETFs invest primarily in stocks from a myriad of companies. These investment instruments provide long-term growth and usually carry comparatively less risk than purchasing individual stock in a company.

Bond ETFs invest solely in bonds, be they government bonds like US Treasuries, corporate bonds, or municipal bonds. An advantage of these specific ETFs is the fact that interest is paid out each month with a dividend, rather than every six months which typically transpires with an individual bond.

Sector ETFs invest in the securities and track the performance of a specific sector or industry. Because sector ETFs are designed to focus on a specific industry, these obviously provided less diversification.

Index ETFs track the performance of indexes such as the S&P 500, or the Dow Jones Industrial Average. Most ETFs available on the market are these types of index-based ETFs.

How do ETFs make money?

ETFs make money by generating a return for investors either by an increase in the price of the specific ETF or from dividends. For example, if the value of stocks within a specific ETF rise, then so does the value of the ETF itself.

For example, say you decide to buy shares in ETF X for $50 per share. If in 12 months, ETF X is selling for $70 per share, then you gain a $20 per share profit if you choose to sell. On the other hand, if the price of ETF X drops in 12 months, then obviously you would experience a capital loss if you choose to sell.

How are ETFs taxed?

One of the benefits of an ETF is that typically this investment instrument in more tax-efficient than mutual funds. Because of the design of ETFs, they are taxed in an identical manner as the underlying assets within the fund, for instance, stocks or bonds. You are taxed on the dividends and interest payments.

In addition, if an ETF is held for over a year, then it will be subject to taxation on capital gains.

Advantages of ETFs over mutual funds?

The primary advantage of ETFs over mutual funds is their lower expense ratio. An expense ratio is defined as expenses incurred to operate a fund.

In addition, there are fewer broker commissions on trades with ETFs - some brokerages do not charge a commission for trading on some ETFs.

Moreover, typically mutual funds have a minimum investment requirement, while an ETF simply charges the share price in addition to any fee or possible broker commission.

How do bond ETFs work?

Bond ETFs invest solely in bonds, be they government bonds like US Treasuries, corporate bonds, or municipal bonds.

An advantage of bond ETFs is the fact that interest is paid out each month with a dividend, rather than every six months which typically occurs with an individual bond.

Do ETFs pay dividends?

It is essential to understand that NOT all ETFs provide dividends. When researching prospective ETFs to invest in, look for the funds “dividend yield” to see if it pays dividends. This will be a percentage denoting the ratio of the amount paid out compared to the fund’s share price.

ETFs vs. Mutual funds?

Typically, ETFs have a much lower expense ratio (expenses incurred for the management of the fund) than mutual funds. Moreover, ETFs can be more tax-efficient than mutual funds. Usually, there is more trading involved within a specific mutual fund, thus resulting in capital gains that are subject to taxation.

ETFs vs. Stocks?

ETFs and stocks are similar in that they both are traded on exchanges throughout the business day, and have an identifying ticker symbol. However, a stock is a security that represents fractional ownership in a company.

On the other hand, an ETF Is an investment vehicle that is comprised of a collection (or basket) of securities like stocks. This is a major benefit of ETFs, because they can balance financial risk by investing in numerous securities at once, thus providing a diversified portfolio.