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What Is An ETF? A Complete Guide For Students

What Is An ETF?

Understanding the terminologies clubbed with technicalities in finance is a little complex and I get it. None of us have all the knowledge available in the world. When it comes to finances, having a reliable source of information is necessary. I hope that by now you know Unicreds is one such trusted platform that will explain all the complicated terms of finances in the simplest manner. A topic that is quite popular but difficult to understand is ETF. Now, the first question you will have is: What is an ETF? So let’s understand everything about the ETF in depth. 

What Is An ETF?

Let’s start by understanding the meaning of ETF and then progress to the details of this term.  

What Does ETF Stand For?

I am sure by now you must be curious to know what does ETF mean, right? ETF is an acronym for Exchange Traded Funds. These funds are essentially a type of security that tracks a particular sector, index, commodity or any other asset but they can be also purchased or sold on a stock exchange in the exact same manner as a regular stock.

What Is An ETF Fund?

I am assuming that you have a little knowledge of stocks and trading. With that assumption, I strongly believe that at some point in time you must have wondered if it was just possible to have the ease of stock trading and the diversification benefit of mutual funds. Well, ETF brings that to reality. An ETF combines the best features of both stocks and mutual funds to create an exemplary investment option for you. 

The ability of ETFs to mimic the ease of stock trading and enjoy the diversification of benefits is a major reason why they are growing more and more popular. This also implies that it can be bought and sold all day long resulting in fluctuation of their price. ETFs usually have lesser fees than all the other types of funds. The risk factor of ETFs varies depending on their sizes. An ETF can be structured to rack either the price of individual commodities or a large number and diverse collection of securities. It can own hundreds or thousands of stocks across various industries. ETFs tend to be more cost-effective and more liquid when compared to mutual funds. 

Summary: Exchange Traded Fund (ETF) are a basket of securities that trade on an exchange, the same way as stocks do. 

If you are still unclear about ETFs then continue reading this guide on What Is An ETF? to gain more clarity. 

Also Read: 8 Best Finance Books Of All Time

What Is An ETF?: How Do They Work? 

Here’s how the ETF works:

  • The fund provider owns a number of assets and creates a basket of them with a unique ticker. 
  • These assets may include stocks, bonds, commodities or currencies. 
  • The fund provider then designs a fund to track the performance of these specific assets. 
  • The shares in this newly designed fund tracker are sold to investors (which would be you). This is as simple as buying shares of the company. 
  • Now you are a shareholder of a portion of the ETF. Do note that you do not own the underlying assets in the fund.
  • You are now free to buy or sell the ETF throughout the day on a recognised exchange. 

NOTE: While the ETFs are technically designed to track the value of underlying assets; they do not necessarily have the market-determined prices that correspond to the assets. 

What Is An ETF? : What Is ETF Trading?

ETF trading is nothing extraordinary. As explained above they act just like stocks of some company and are eligible to be traded on an exchange. Thus, ETF Trading involves buying and selling stocks all day long at prices that seem reasonable to the traders. 

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What Is An ETF? : Types of ETFs

The various types of ETFs are listed below:

  • Bond ETFs: These include government bonds, corporate bonds, and municipal bonds.
  • Industry ETFs: They track a particular industry such as technology, banking, or the oil and gas sector.
  • Commodity ETFs: As the name suggests, they invest in commodities including crude oil or gold.
  • Currency ETFs: They invest in foreign currencies such as the Canadian dollar or Euro.
  • Inverse ETFs: These ETFs attempt to earn gains from stock declines by shorting stocks. 

What Is An ETF? : Pros and Cons

The following are the pros of ETFs.

  • ETFs bring the broadest sense of diversification along with them. 
  • The knowledge of underlying assets places you in a position to monitor their value directly and observe the prices of your ETF which introduces the angle of transparency. 
  • There are multiple tax benefits in ETFs because you are charged only for selling the investment. 

The cons of ETFs are listed below:

  • There exist decent trading costs because they are exchange-traded. You will have to pay commission to online brokers. 
  • ETFs aren’t traded as frequently and it might be harder to unload at times. 

It goes without saying that the risks associated with the stock market come hand-in-hand with ETFs. 

Are ETFs Better Than Mutual Funds? 

ETFs, on average, offer lower costs than mutual funds, which is one of their biggest selling points. For equities mutual funds in 2019, the average annual administrative expenditure (also known as an expense ratio) was 0.52 percent. The average cost ratio for index equity ETFs was 0.18 percent. Investors can also benefit from the tax efficiency of ETFs.

A mutual fund (particularly one that is actively managed) has a higher turnover rate than an ETF, and this buying and selling might result in capital gains. 

When investors choose to sell a mutual fund, the management will need to generate cash by selling securities, which can result in capital gains as well. Although ETF for beginners is becoming more popular, there are still more mutual funds accessible. The management structures of the two items are also distinct (typically active for mutual funds, passive for ETFs, though actively managed ETFs do exist).

Are ETFs Better Than Stocks? 

ETFs, like stocks, are traded on exchanges and have distinctive ticker symbols that allow you to follow their price movement. ETFs, unlike stocks, represent a group of equities rather than a single business. ETFs may provide better diversity than a single stock since they own many assets. This diversity might assist to decrease the risk in your portfolio.

What Is An ETF? How To Find The Right ETF For Your Portfolio? 

It’s important to be aware that while costs generally are lower for ETFs, they also can vary widely from fund to fund, depending on the issuer as well as on complexity and demand. Even an ETF tracking the same index has different costs. The majority of ETFs are index-tracking instruments that are not actively managed. Some investors choose mutual funds, which are managed by a professional manager who attempts to outperform the market. There are actively managed ETFs that mimic mutual funds, but they come with higher fees. So consider your investing style before buying.

With the growth of this industry, certain funds have emerged that may not be worth investing in borderline gimmicky funds that focus on a narrow segment of the market and may lack diversification. Just because an ETF is inexpensive does not guarantee it is a good fit for your overall investing strategy.

Thank you for reading this blog on What Is An ETF? A Beginner’s Guide. If you enjoyed reading this blog then the following blogs may be of interest to you.

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What Is An ETF?

What Is An ETF? A Complete Guide For Students