What is an ETF?

An ETF or exchange traded fund is a group of stocks that tracks an index. A well known example of a market ETF is SPY. SPY tracks 500 large US companies. These are companies which have common stock listed on several stock exchanges. You can buy or sell ETFs on the open market just as you would individual stocks. Because ETFs are composed of a group of stocks, they provide a way to diversify your portfolio. Keeping a diversified portfolio helps to insure that the decline of an individual stock does not adversely effect your entire portfolio.

Growth in ETFs by Year Chart

While the first ETF appeared in 1993 by 2008 there were 728 ETFs. Fast forward to 2019 and there are over 5,000 ETFs to choose from. ETFs come in different types:

  • Bond ETFs
  • Commodity ETFs
  • Currency ETFs
  • Exchange-Traded Notes
  • Foreign Currency ETFs
  • Foreign Market ETFs
  • Inverse ETFs
  • Market ETFs
  • Sector and Industry ETFs
  • Style ETFs

Bond ETFs are exchanged-traded funds that invest exclusively in Bonds. While bond ETFs track an index of bonds they also provide several advantages. The advantages of Bond ETFs generally include: price transparency, Liquidity, and Diversification. Examples of Bond ETFs include:

  • First Trust Low Duration Opportunities ETF
  • Invesco BulletShares 2024 Corporate Bond ETF
  • iShares Interest Rate Hedged Corporate Bond ETF
  • iShares MBS ETF
  • SPDR Bloomberg Barclays 1-3 Month T-Bill ETF
  • SPDR Bloomberg Barclays High Yield Bond ETF

A Commodity ETF is type of ETF that invests in commodities. If your interested in gaining exposure to metals like gold and silver or another type of commodity then a commodity ETF may be a good way to diversify across multiple commodities. Examples of commodity ETFs include:

  • Aberdeen Standard Platinum Shares ETF
  • Invesco DB Agriculture Fund
  • iPath Dow Jones-UBS Commodity ETN
  • ProShares Ultra Silver
  • United States Commodity Index Fund
  • VelocityShares 3x Long Natural Gas
  • Currency ETFs

ETFs that invest directly in foreign and or domestic currencies are called Currency ETFs. Currency ETFs are traded in pairs and can be used for short or long dollar strategies. Knowing how the fund is structured is helpful in determining risks. Examples of currency ETFs include:

  • CCX – WisdomTree Dreyfus Commodity Currency Fund
  • DBV – PowerShares DB G10 Currency Harvest ETF
  • ERE – EFXY – CurrencyShares Japanese Yen Trust
  • ERE – ELEMENTS Euro / USD Exchange Rate ETN
  • GBB – iPath GBP / USD Exchange Rate ETN
  • UUP – PowerShares DB US Dollar Index Bullish ETF

Exchange-traded notes are unsecured debt securities which are issued by an underwriting bank. ETNs trade on an exchange like ETFs and their returns are based on the performance of a market index at maturity.

Foreign Market ETFs offer the opportunity to invest in a basket of foreign publicly traded companies. A foreign market ETF can be a way to invest in a specific country while staying diversified within that country. Examples of foreign market ETFs include:

  • IGRO – iShares International Dividend Growth ETF
  • Schwab International Equity ETF
  • Vanguard FTSE Developed Markets ETF

Inverse ETFs are ETF products that are created using derivatives to profit from the underlying benchmarks declining value. Market ETFs like Vanguard’s VOO which closely tracks the S&P 500 index are among the most traded ETFs. This is in part because VOO tracks a major US stock market index. It does this while offering a very low expense ratio. The Investco QQQ ETF is a good example of a sector and industry ETF. QQQ is overweight in the Technology and consumer cyclicals industries.

Exchange-traded funds that track a specific style or asset class are called Style ETFs. Style ETFs target a specific focus. This includes value investing, growth investing, dividend investing and others. Examples of style ETFs include:

  • iShares International Select Dividend ETF
  • iShares MSCI EAFE Value ETF

ETFs have several advantages over investing in a single company stock. ETFs can group equities by sector, style, market and industry. Broader ETF configurations can allow for results grouped by country or groups of countries. The mix of company types included in the ETF provides a degree of diversification. Limited capital gains tax and lower fees on the ETF product are also considerations when making your purchase.

Lower trading volume and inactivity are two disadvantages to watch out for. Lower trading volume produces too wide of a bid ask price spread lowering the overall return on your investment. Inactivity can cause delays when buying or selling an ETF with few buyers and sellers.

Exchange-Traded Funds offer a wide variety of options for the investor that is interested in targeting a specific investment approach while maintaining diversity. Not all funds offer the same level of diversity and some are more balanced than others. In addition to the risks of investing in ETFs, investors should also be aware of the administration fee charged to run the ETF. This can have a real effect on how fast ETF gains can compound over time.

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