The Beginner’s Guide to ETFs 

What is an Exchange-Traded Fund?

An exchange-traded fund (ETF) is a type of pooled investment security that operates a lot like a mutual fund. Unlike a mutual fund, it can be purchased or sold on a stock exchange just like a regular stock. ETF share prices fluctuates multiple times a day as the ETF is bought and sold. ETFs can contain all types of investments, including stocks, commodities and bonds. An ETF can own hundreds or thousands of stocks across various industries, or it could be restricted to one particular industry. Some funds focus only on U.S. offerings, while others are international.

So, an ETF is similar to a mutual fund in that it holds underlying assets, rather than only one like a stock does.
But it is similar to a stock in that it’s traded on an exchange, with the price of its shares changing throughout the trading day.

Simply put, ETFs are considered by many to be mutual funds that can be traded like stocks.

ETFs: Benefits

Relatively low-cost investing

ETFs tend to have lower costs than many other types of investments such as mutual funds. Most ETFs don’t need to be actively managed which means investment managers are fairly hands-off. Instead of trying to buy and sell stocks to gain an edge on the market, they only need to buy and sell what’s needed to keep the ETF tracking its intended investment mix. This lower cost, over decades, adds up, saving a lot of money.

Diversified investments

A diversified portfolio is important because it means you don’t have to put all your eggs in a single basket. Since a single ETF can hold many different types of investments, even one or two/three ETFs helps you minimize your investment risk by spreading it out. It’s worth keeping in mind that while some ETFs do focus on a particular sector, they still tend to be diversified across many companies within that sector.

Tax-efficient

ETFs are definitely more tax-efficient for investors than mutual funds. This is because most focus on passive or index investing which means there aren’t as many trades that take place compared to actively managed mutual funds. As you probably know, trades cause capital gains and losses in mutual funds and these are then distributed to the fund holders. The distributions are taxable if the mutual funds are held in a taxable investment account. Due to the nature of ETFs, capital gains and losses tend to be small. This helps lower your tax burden until you’re ready to sell.

Traded on exchanges

Unlike mutual funds which trade once per day, ETFs trade throughout the day on the exchanges. This makes a huge difference for investors who want more control over when and how they invest. Let’s take an example. Say a large event in the market causes investments to drop (or rise) drastically throughout the day, if you want to be buying and selling during a particular hour in the day, you can do so with ETFs.

Of course, like anything else in life, ETFs have their drawbacks. But the diversity they offer and the simplicity make them an investment definitely worth considering.