Invest With An Edge

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ETF

Are ETFs (Exchange Traded Funds) good for investment? ETFs also referred to as ‘smart beta,’ is a notable investment medium that tracks market indexes to determine where people should invest.

People use them as a pool for the financial resources to purchase several monetary assets which are tradable. Some of the prime examples of ETFs are shares, debt securities, derivatives, and bonds. Even foreign currency falls into the category of EFTs.

ETFs are no different than stocks are they are traded during trading periods, often with fluctuation in prices. The price of a single ETF is determined based on the conventional theory of supply and demand.

ETFs amalgamate the potential benefits and features of stocks, bonds, and mutual funds as a pocket full of securities. ETFs are characterized by securities that aid in formulating risks and returns on investment in the financial realm. [5]

In this article, readers will learn about the similarities/dissimilarities of ETFs with mutual funds, types of ETFs, their advantages and shortcomings.

Brief Overview On ETFs And Mutual Funds

ETFs and mutual funds share a peculiar similarity, i.e., investors do not own them completely. The indirect or the partial claim does give investors a portion of profits alongside residual value when ETFs are liquidated. If need be, investors can sell the said shares in secondary markets.

Both ETFs and mutual funds comprise distinctive assets which investors can seamlessly diversify. The primary difference between the two is that ETFs are traded like stocks, whereas mutual funds are purchased at the end of each trading day. As ETFs are passively managed, investors can buy and sell them just like stocks. [2]

Types Of ETFs

There are distinctive ETFs where each type focuses on a unique investment type. Let\’s explore them!

  • Bond ETFs: These are the funds that are invested in bonds of any index. They are traded on the exchange. With these ETFs, investors can buy or even sell all through the day with a nominal price tag. They are an ideal choice to manage debt funds.
  • Stock ETFs: They hold a specific portfolio of both stocks and equities. Additionally, they showcase peculiar similarities with that of the index. Investors can either treat stock ETFs like regular stocks where they are sold/purchased for profits.
  • Commodity ETFs: As the name suggests, commodity ETFs hold the conventional physical commodities like natural resources, agricultural goods, and precious metals. A few commodity ETFs possess an amalgamation of investments along with equity investments. For instance, if an investor has a gold ETF, it resonates with the value of physical gold according to the stock shares.
  • Index ETFs: They mimic indexes just like S&P 500. Index ETFs cover particular stock classes, sectors, emerging or foreign markets equities.
  • Inverse ETFs: They come into being by employing different derivatives with the intent of gaining profits. The idea is to make sure of short selling when there is a subtle decline in the market index and security groups.
  • Currency ETFs: You’ll find Currency ETFs in different currencies or a single-most currency. They are broadly used by investors who like to explore the international exchange market without trading with the forex market or trading futures. Also known as the exchange-traded funds, currency ETFs track the Canadian dollar, USD, Euros, Yen, and British Pound.
  • Leveraged ETFs: They comprise the financial derivatives to leverage the overall investments and at the same time amplify gains. Traders and speculators benefit greatly from short-term trading in significant stock indexes.
  • Actively Managed ETFs: Usually managed by a team of investors and manager who allocates portfolio assets. As these ETFs are managed actively, the turnover rates are significant due to higher portfolios.
  • Real Estate ETFs: They are the funds that are generally invested in REITs, aka Real Estate Investment Trusts. Investors also use these funds in companies that develop real estate, service firms, and, lastly, mortgage-backed security. These funds are the obvious choice for developing massive commercial properties. [1]

Advantages Of ETFs

  • Lower Costs

As they are no different from stocks, people can buy a comprehensive, diversified portfolio; they come in cheap too.

  • Liquidity

They are seamlessly tradeable. Meaning you can trade them right now; why should you wait for a special day.

  • Instant Diversification

The U.S. stock exchange comprises more than a hundred ETF trading. The diversification is broad and deep and covers significant sectors, indices, industries, and strategies. If you\’re looking for a long/short-term income, then ETFs are a perfect choice.

  • Tax Efficiency

They’re not usually managed actively but are programmed to a particular index that can incur high gains with it, high income.

  • Has Alternative Investments

They empower investors to take positions in exotic and alternative investments which aren\’t available to small-time investors. [3]

Disadvantages Of ETFs

Even with insurmountable benefits, ETFs have encountered massive challenges over the years. Some of them are:

  • Lacks Rebalancing

Most ETFs do not reflect any rebalance in the portfolio. It usually is an ETF that tracks an index, and as winners keep on increasing, the index percentage would also become more massive than ever.

The price of some stocks declines with the decrease in index percentage. If you happen to own the index, the ETF that tracks the index may become hefty with overpriced stocks and opens avenues for fewer bargains.

  • Massive Diversification

Most of the ETFs revolve around diversification, and they\’re not actively managed either. Nevertheless, as they are programmed to follow a particular index, the stocks might not be optimum.

To overcome this ordeal, ensure that you purchase ETFs minimally from the best companies rather than owning a bulk. [4]

Final Thoughts

For new as well as experienced investors, ETFs are the perfect vehicle of investment. If you have a small portfolio, you can leverage the diversification that this kind of investment offers. Additionally, investors with extensive portfolios can make use of diversification across any industry, sector, or geographical area. If you happen to use ETFs wisely, it will prove to be a valuable tool that lowers the risk or even improves the return on the portfolio.

References:

  1. https://www.forbes.com/sites/baldwin/2021/03/05/which-is-better-an-etf-or-a-mutual-fund/?sh=744e3ee779a4
  2. https://www.nytimes.com/2008/12/16/your-money/mutual-funds-and-etfs/primerETF.html
  3. https://www.forbes.com/advisor/investing/what-are-etfs/
  4. https://www.investopedia.com/articles/exchangetradedfunds/11/advantages-disadvantages-etfs.asp
  5. https://www.thebalance.com/what-is-an-etf-1214813
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