A beginner’s guide to the ETF

A beginner’s guide to the ETF

ETF – a fund that behaves like a stock.

In almost a quarter of a century, ETFs have become one of investors' preferred trading instruments (sec.gov).

In today's article, we will discuss some significant points that can help investors who want to give ETFs a shot. After reading this article, we hope you will know how ETFs function and what their role in trading is.

What is an Exchange Traded Fund

An exchange-traded fund (ETF) is one of the few assets that you can trade like a stock on an exchange. ETFs consist of a collection of securities (such as stocks, bonds, treasury bills) that usually tracks an underlying index. As they can include so many different types of securities, investors have the possibility to trade a basket of assets without transacting each component separately.

An ETF can contain stocks from various industries or focus on a single sector, such as banking or U.S-only products.When it comes to an exchange-traded fund's price, this can vary throughout the day as it is bought and sold.

History

1989 - According to the author of "The Exchange-Traded Funds Manual," Gary Gastineau, investors first took a shot at creating something that resembled today's ETF. It was the year when the Index Participation Shares for the S&P 500 appeared.

1990 - After one year, the Toronto Stock Exchange created the Toronto 35 Index Participation Units (TIPs 35) – a receipt-based instrument designed to track the TSE-35 Index.

January 22, 1993 – the S&P 500 Trust ETF (SPDR) was released by the State Street Global Investors, which is one of the most actively-traded ETFs to this day.

1996 – Barclays started including ETFs in its portfolio.

2001 – ETFs began to be offered by Vanguard.

December 2019 - more than 7,000 ETFs were traded globally.

Types of ETFs

As the number of underlying assets varies, so does the types of ETFs. Let's see some of the ETFs available for trading:

  • Commodity ETFs: the name speaks for itself. This type of fund focuses on investing in commodities such as Oil or Gold.
  • Currency ETFs: allow investors to trade foreign currencies.
  • Bond ETFs: can include state or local bonds (municipal bonds), corporate bonds, and government bonds.
  • Industry ETFs: focuses on one industry like banking, technology, and others.
  • Inverse ETFs: focuses on short selling – a trader attempts to profit by selling a stock whose price he thinks will fall, and then repurchases it at a lower price.
  • International ETFs: this can help an investor build a diverse portfolio. Such funds include investments in a single country or country blocs.

Examples of ETFs

To better understand ETFs, we have compiled a list of ETFS based on their assets’ value.

  1. The largest and most important is the S&P 500 SPDR, listed on the New York Stock Exchange.The value of one share is roughly a tenth of the S&P 500 current level. In 2013, it was the world’s most traded ETF, with an average daily volume of 117 million shares. As of May 2020, this exchange-traded fund had roughly $253 billion worth of assets under management.
  2. The second-largest ETF in the world is the iShares Core S&P 500 ETF. It became tradable in 2000, and in May 2020, it had under management $176 billion in assets. The daily average trading volume reached 8.6 million shares.
  3. With $101 billion in held assets comes the Invesco QQQ, which mimics the Nasdaq 100 Index. The ETF became tradable in March 1999.
  4. Having around $43.4 billion in assets is the non-US ETF – MSCI EAFE ETF, which came on the market in August 2001.
  5. In just 17 years since its launch, the Barclays TIPS grew to $20 billion in assets as of March 2020.

Pros and Cons of trading ETFs

Like any other type of investment or asset, ETFs have advantages and disadvantages. Let’s start with the pros:

  1. Diversification – with ETFs, you can diversify your portfolio across industries because it would take someone a considerable amount of money and time to trade all the specific basket components.
  2. Transparency – the holdings of an ETF are presented daily to the public; moreover, one can check any ETF price on an exchange.
  3. Tax benefits – investors pay when they sell.
  4. Easy to trade - an ETF acts like a stock.

Now that we've established the main strong points of an ETF, let's see its weaker sides:

  1. Costs: although we said before that trading an ETF is cost-efficient, there are times when it can experience lower liquidity, making it harder to sell.
  2. Closure: if the assets’ value is not enough to cover the ETF administrative costs, investors have to close their positions sooner than expected. This action can lead to losses.

How to trade it

Now that we learned so much about ETFs, one question arises: how to trade an ETF? The answer is straightforward: just like any other CFD product – through brokers.After an investor finds a suitable broker and discovers the ETF’s ticker symbol, he can place orders like for any other stock.

Now that you’ve made it this far, feel free to take a look at our variety of ETFs, and see which one suits you better.

But with the advancement of technology, some robot-advisors use ETFs in their investment products, like Betterment and Wealthfront. They will invest in ETFs on your behalf, following an investment plan based on your goals and risk tolerance.

Conclusion

ETFs, as they include stocks from many companies, are popular among investors. However, the emergence of new exchange-traded funds led to low trading volumes as far as some ETFs are concerned. It means that investors are not able to trade a low-volume ETF easily.

The ETFs can also inflate the stock value and create bubbles, which can harm the stability of the market, as some of them are based on portfolio models that have not been tested in various market conditions. ETFs can create massive inflows and outflows, and that’s why allegedly, ETFs played a role in 2010, 2015, and 2018 market declines.

Though they seem easy to understand, the ETFs are more than meets the eye. But since you now have the foundation, you can start integrating these assets in your investment portfolio and adapt your trading strategies to it.

Feel free to visit our Trading Academy to find out more about various assets. Also, our Financial Dictionary consists of the most used terms in the market. If you want to stay informed, check out the Featured Articles and Market News sections. Do you want an expert’s point of view? See what an analyst with more than 30 years of experience has to say!

Sources: nerdwallet.com, investopedia.com, financialdictionary.net, forbes.com


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