What is an ETF: Things You Need to Know

An exchange-traded fund, more popularly known as an ETF is nothing but a collection of securities, stocks, bonds, commodities. ETFs can be bought and sold via a broker. ETFs come with the best features of two popular assets: they come with the trading convenience of stocks and the diversification benefits of mutual funds. If you have ever wondered “What is an ETF”, this post will have your answer, along with a brief introduction to the other aspects of the world of ETFs. Let’s get started. 

What is an ETF: Valuable Information

What does ETF stand for?

An exchange-traded fund — better known by the acronym “ETF” is a type of fund that’s usually traded on an exchange as a sort of stock. With the help of an ETF, you can buy a bunch of assets without shopping for them individually.

What are Gold ETFs?

Gold ETF is a special type of exchange traded fund that tracks the price of gold.

What are Liquid ETFs?

Liquid ETFs are the money market ETFs, the investment objective of which is to provide money market returns. Liquid BeES launched by benchmark mutual fund is the first money market ETF in the world. Liquid BeES will invest in a basket of call money, short-term government securities and money market instruments of short and medium maturities.

How does an ETF work?

This is basically how an ETF operates: The fund provider owns the underlying assets, designs a fund to trace the performance then sells shares of the fund to investors. Shareholders own some of an ETF, but they don’t own the underlying assets within the fund. Even so, investors in an ETF that tracks a stock market index get lump dividend payments, or reinvestments, for the stocks that structure the index. 

How is the market price of an ETF determined?

The market price of an ETF is determined by the prices of the stocks and bonds held by the ETF as well as market supply and demand.

The market price can change throughout the trading day and may be above or below the total value of the stocks and bonds the ETF invests in. Though the difference is usually small, it could be significant when the market is particularly volatile.

Are there any tax advantages to owning an ETF?

Similar to conventional index mutual funds, most ETFs try to track an index, such as the S&P 500. An index ETF only buys and sells stocks when its benchmark index does. Big investment moves—like when a company is removed from the index completely—happen very rarely.

In addition, ETF managers can use capital losses to offset capital gains within the fund, further reducing (or possibly eliminating) the taxable capital gains that get passed on to fund shareholders at the end of each year.

What kind of prices do ETFs trade for?

While ETFs are designed to trace the worth of an underlying asset — be it a commodity like gold or a basket of stocks like the S&P 500 — they trade at market-determined prices that sometimes differ from that asset. What’s more, due to things like expenses, long-term returns for an ETF will vary from those of its underlying asset. The market price of an ETF is determined by the prices of the stocks and bonds held by the ETF as well as market supply and demand.

The market price can change throughout the trading day and may be above or below the total value of the stocks and bonds the ETF invests in. Though the difference is usually small, it could be significant when the market is particularly volatile.

How to invest in ETFs?

Open a brokerage account

In order to buy and sell ETFs, you need to have a brokerage account. ETF trades are available during trading hours for the major stock market exchanges but having a broker makes it easier. For example, a good amount of brokers who offer their own ETFs, allow you to trade their proprietary ETFs with no commission. There are also a few brokers who have partnership arrangements with third-party ETF providers who don’t charge an extra commission on ETF trades. Getting a brokerage account helps you see what they offer, which ETFs they have their hands on, and if it matches your requirements. 

Select the fees that you are comfortable paying

There are many fish in the sea of ETFs and it can get confusing. One way to identify strong prospects is to look at their relative costs. Other aspects of the financial markets are more costly, and so you might see higher absolute expense ratios in certain areas. For example, investing in international stock comprises more logistical challenges, and so the expense ratios are higher than for U.S. stock funds. When you study ETFs from different fund families, the least expensive will often end up giving you the best opportunity for the highest returns.

How do you pick the least expensive ETFs? Well, ETFs have an annual expense ratio, which represents the percentage of total fund assets that go toward covering the costs that the ETF incurs every year. Lower expense ratios mean more money that you save. Keep in mind that the biggest and most efficient ETF providers have expense ratios for their funds that can be less than 0.1%.

Ensure that your ETF portfolio is diversified

A lot of ETF holdings have similar investments, and so just by owning more ETFs, it doesn’t necessarily mean that you have a diversified portfolio. The underlying holdings on your ETF can be almost the same. So what you can do is to look for ETFs that are in different categories. 

Incorporating different asset classes, such as stocks, bonds, real estate, etc. can be a good starting point. Such asset classes help to broaden your exposure too. When it comes to stocks, having different ETFs that have different geographical exposure, and different sectors and industry presence will go a long way toward a diverse portfolio. This will reduce your risk too.

Keep adding on to your ETF holdings

Learn to make automatic investments on a regular basis, with the help of brokers. By doing this, when your broker offers commission-free ETF trades, you won’t have to worry about the expense of putting small amounts of money to work for you as soon as they’re available. Paying even a $3 commission doesn’t make sense if you only have $100 per month to invest in an ETF, and if you’re in a situation in which you do have to pay a commission, it can be smarter to make less frequent investments so that your commission costs represent a smaller percentage of what you’re investing.

What are the differences between ETFs and Futures?

Though ETFs and Futures provide an exposure to the same underlying index, the differences between them are:

  • ETFs trade in much smaller investment sizes than a futures contract making it possible for retail investors to participate in index investing.
  • Futures trading requires an account with a broker having a derivatives terminal and are subject to margin requirements prescribed by the exchanges.
  • Futures involve significant leverage which magnifies losses in the vent of prices moving against the positions held by the investor.
  • Futures contracts must be rolled over every three months (or every one month if liquidity is poor in far month contracts) which can lead to higher trading costs and tracking error.

What happens in case of default on payment or delivery of ETFs?

As clearing and settlement are done through the exchange, the exchange’s clearing house guarantees all trades. Any shortfall in units will be auctioned by the exchange and the investor is protected by the exchange mechanism.

Can ETF units be used for paying margins to the Stock Exchange?

  • Liquid BeES ETF units can be deposited by the members with the exchange towards collateral requirements (liquid assets) for margin purposes. These units will be considered as a cash equivalent.
  • Other ETF units can also be deposited towards collateral requirements. However, these units will be considered as non-cash equivalents.

What’s the difference between ETFs and Mutual Funds?

Flexibility

ETFs are freely traded within the market and may be bought and sold as per the investor’s convenience. Their market value is out there in real-time (a bit like ordinary equity shares). Mutual funds units are often bought or sold only by placing an invitation with the fund house. NAV indicates the price of 1 unit of a mutual fund.

Fees and Expenses

As ETFs merely replicate the performance of an index, active management is not required for them. As a result, the fees and expenses related to ETF investments are low. With regards to Mutual Funds, the fund manager actively takes investment decisions on behalf of the investors. The fund management expenses tend to be on the higher side as a result.

Commissions

As ETFs are traded like all other shares on the exchange, investors are required to pay commissions on the sale and purchase of units as per the prevailing rules. Conversely, in the case of mutual funds, there’s no requirement for paying any commission for the sale and purchase.

Management

Mutual funds are generally managed by an experienced fund manager who is incharge of all the decisions on behalf of the investors. As far as ETFs are concerned, the funds merely track the market index. There are some actively managed ETFs also, but they need a better expense ratio.

Lock-in Period

ETFs don’t have a minimum holding period, and therefore the investors have the freedom to sell the investment whenever they want to. Mutual funds like ELSS (Equity Linked Savings Scheme) accompany a lock-in period of three years. During this timeframe, it’s impossible to liquidate the investment. This can range from 9 days to three years, depending on the selected mutual fund scheme.

How to choose between ETFs and Mutual Funds?

Both mutual funds and ETFs are great for creating a diversified portfolio. The final choice between the two should be made on a number of factors. Some of the most crucial ones to consider are::

  • Ease to liquidate the investment
  • Your risk appetite
  • Your investment horizon
  • The tax-saving strategy that you have.
  • Your financial goals

Based on some introspection and an honest assessment of your goals, you can choose whether you should invest in an ETF or a mutual fund. At the end of the day, they both have similarities and they both have their differences. They also have their own pros and cons. Weight them thoroughly before you decide to invest in either.

What is an ETF: Best Quotes

“There shall be an ETF for every asset class, and it shall be virtually free to own.” – Matt Hougan & Dave Nadig via ETF.com

“One of the most attractive elements of ETFs is their cost structure. Because ETFs are based on indexes, there’s no need for a staff of two-dozen, Porsche-driving Harvard MBAs, so a minimum of your hard-earned money is consumed managing the indexes.” – The Motley Fool

“The growth of ETFs in U.S. capital markets is a textbook case study in ‘Disruptive Innovation’, right alongside well-known historical examples like Amazon, Google, Facebook, Netflix and scores of other successful enterprises.” – Nick Colas, ConvergEx

“No invention has been more disruptive to the asset-management industry in the last quarter-century than the exchange-traded fund.” – Crystal Kim, Barron’s

“ETFs are fundamentally a technology. They are mechanisms to achieve a certain goal, like phones. Traditional mutual funds were rotary phones. ETFs are smartphones: They do the same thing but are in a better package.” – Dave Nadig, ETF.com

“If there’s a comparable stock ETF available, it should be no contest after-tax – the vast majority of active stock funds are likely to lag it.” – Jeffrey Ptak, Morningstar

“Those of you who make investments outside of any retirement accounts are absolutely crazy if you are using actively managed funds rather than ETFs.” – Suze Orman

“Think of ETFs as the market’s version of a wolf pack picking off and weeding out the slower and weaker active fund managers in the herd, those with consistently poor returns and high fees.” – Vito J. Racanelli, Barron’s

“ETFs can offer many attractive features, but their long-term value depends on how well they fit into any individual portfolio. To evaluate appropriate fit, investors have to be prepared to look under the hood.” – John Feyerer, Invesco

“95% of media coverage is on ETFs comprising 5% of your portfolio.” – Eric Balchunas, Bloomberg

“Talking about ETFs is like talking about people. There are good ones, and there are bad ones.” – Jack Bogle

ETF Trading

“Have good trading hygiene.  The vast majority of ETFs deliver on their core promise to investors. But if you trade them poorly, that’s probably on you.” –Dave Nadig, ETF.com

“Blaming a stock bubble on ETFs is like blaming MP3s for Nickelback or One Direction.” – Eric Balchunas, Bloomberg

“It’s exhausting debunking the regular stream of caustic mythology around ETFs. There’s a bull market in hyperbole headlines around ETFs, and it’s been going on since the 1990s.” – ETF.com’s Dave Nadig

“Whenever something goes bad, we now blame ETFs. But it’s one of the greatest financial innovations of all time.” – Deborah Fuhr, ETFGI

“Bear markets occurred before the invention of the ETF and have occurred after. At the conclusion of the next bear market, the ETF structure will still be there intact.” –Tadas Viskanta, Abnormal Returns

“ETFs are simply vehicles to access markets. These vehicles are driven by humans. Humans, not ETFs, drive markets.” – Yours Truly

“ETF portfolios will be the inevitable default for investors in the years to come because they are lower cost, more transparent and offer greater liquidity and tax advantages than mutual funds.” – Jon Stein, Founder & CEO at Betterment

“There is a manifest destiny for ETFs.  That they are the structure people will use to get exposure to securities in the future, and mutual funds will be banished to the dustbin, like typewriters have been replaced by computers.  It’s just a better technology and so it will come to replace funds over the next 20 years.” – Matt Hougan, Chairman of Inside ETFs

“ETFs aren’t just having a moment. They’re creating a movement.” – Martin Small, Head of U.S. Wealth Advisory at BlackRock

Now that you are done reading this post, you will hopefully have a better idea of what ETFs are. Continue your research and try making some investments in ETFs. Good luck!

Get in Touch

LEAVE A REPLY

Please enter your comment!
Please enter your name here

Related Articles

What is Adventure Gold (AGLD) and Loot NFT Project?

Adventure Gold or AGLD is an Ethereum token that was airdropped to the Loot non-fungible NFT project owners. Loot is a text-based randomized adventure...

Why Do Bitcoin and Other Cryptocurrencies Charge Transaction Fees?

Cryptocurrencies are designed in a way so that traders can trade them across every online network without any interference from the government or bank....

What Flat Renters Should Look for Before Selecting the Building Floor?

Are you planning to move to Bahrain or finding a ready-to-move-in flat in the country? Bahrain has an abundance of affordable residential properties and...

Get in Touch

22,878FansLike
3,515FollowersFollow
0SubscribersSubscribe

Latest Posts