If you are just starting out in the investing and/or trading field, you likely have heard the term ETF stock mentioned many times. An ETF stock is different from a stock of a singular company and entails a lot more information. An ETF allows for any investor to gain exposure to the market without the risk of depending on one singular asset.
So what exactly does an ETF stock have and what is it? In this article, we will go over the basics of an ETF stock, the benefits and disadvantages of an ETF, and how you can add an ETF stock to your portfolio for investment or trading purposes.
- What is an ETF Stock?
- ETF vs Mutual Funds vs Stocks
- Types of ETFs
- How to Invest in an ETF
- Advantages of an ETF
- Disadvantages of an ETF
What is an ETF Stock?
An ETF (exchange traded fund) stock is an asset that is made up of a particular number of equities like stocks, bonds, and/or commodities that can be bought and sold like a regular stock through a broker. An ETF offers the benefits of a mutual fund in its diversification and the advantage of trading it like a normal stock with its own price. An ETF makes it easy to buy or sell a number of assets without having to buy one at a time. ETFs can be tracking an entire sector like energy or can be an entire index fund like the S&P 500 (SPY).
The fund provider owns the underlying assets and designs the fund to track its performance and then sells shares in the fund to investors with a unique ticker. Those who buy the ETF own a part of the ETF but not the underlying assets in the fund itself. Dividend payments are still paid from the stocks in the index. ETF prices are determined by the market and mostly differ from the price of the underlying asset it represents.
ETF vs Mutual Funds vs Stocks
For the most part, an ETF has lower fees than mutual funds, which is why it is so popular with investors. ETFs also have tax advantages when compared to mutual funds, as it is more likely to have capital gains with mutual funds because of the higher turnover. Mutual funds have an active management structure while ETFs have passive ones. ETFs like stocks can be traded on an exchange and have their own ticker symbol to track their prices. A stock represents one company while an ETF is a basket of different assets.
Types of ETFs
There are different types of ETFs to choose from for investors to use as an income generation, trade, to hedge or offset risk in an investor’s portfolio. The ETF that interests you depends on your goals for your portfolio and where you have confidence and knowledge to invest in. The types of ETFs include the following:
- Currency ETFs – which is an investment in international currencies like the Euro or Yen.
- Commodity ETFs – which is an investment in commodities like gold or crude oil.
- Inverse ETFs – earns gains from the decline of a stock. Shorting is to sell a stock when you expect a decline in value, and buying it again at a lower price. Many inverse ETFs are exchange traded notes which is a bond traded like a stock.
- Bond ETFs – can include bonds from the government, state and local, as well as corporate bonds.
- Industry ETFs – is an investment in a particular industry like banking, gas or technology.
How to Invest in an ETF
Investing in an ETF is just like investing in a regular stock since you can head straight to your brokerage an buy the particular ETF with its ticker symbol. For those who know what kind of ETF they want to buy, it is as simple as typing in the ticker symbol from their broker. Some examples of well-known ETFs include the SPY which is the most well-known ETF which tracks the S&P 500 Index. The SPY is the most actively traded asset with a daily average volume in the millions. The QQQ tracks the technology stocks and indexes the Nasdaq 100 and the IWM tracks the Russell 2000 small-caps.
Well-known sector ETFs include the OIH for oil and XLE for energy, along with physically-backed ETFs like GLD and SLV for gold and silver respectively. Commodity ETFs include crude oil USO and natural gas UNG. If an investor decides to buy an ETF, he/she is gaining exposure into the equities of an index or sector without buying each individual stock. There are minimum management fees so traders of any skill can buy ETFs to receive consistent returns while having minimum costs.
Depending on your goals as a trader and interests, you might want to trade specifically in a commodity like natural gas or trade high volume, well-known ETFs like the SPY. Some traders specialize in a specific ETF and get to know its movements and history, while others want to invest in the major stocks of the market without exposing themselves to one particular company. More and more investors are putting their money in ETFs because its a simple product to understand, it is relatively cheap and there is exposure to a diversified product in the market.
Advantages of an ETF
What are the advantages of buying an ETF for an investor? ETFs allow an investor exposure into the market by buying a set of stocks in the ETF rather than by buying these individually. If the investor had to buy each stock individually, it would be much more expensive than buying a single ETF. There is one transaction to buy and another to sell so it also simplifies the process and less commissions by the broker. There are brokers who also offer no fees on certain ETFs. When an investor buys an ETF, they are choosing to diversify the portfolio since an ETF tracks a lot of assets at once.
ETFs have a transparent price that can be easily searched for online. The fund’s holdings are known on a daily basis, while with mutual funds this is known on a monthly or quarterly basis. For active investors, this is a great option to have in order to track how the ETF is doing regularly. When it comes to taxes, investors are taxed when the ETF is sold, while with a mutual fund, taxes are incurred throughout the investment.
Disadvantages of an ETF
While there are advantages to buying an ETF, there are also some disadvantages to consider before getting an ETF in your porfolio. There are still trading costs to consider when trading ETFs. Although most brokers have decided to drop commissions, there are still some fees involved depending on the brokerage. It is important to do your research to understand if there are commission fees to trading ETFs.
If you are looking to trade ETFs, it is important to consider the trading volume. Once you buy the ETF, you also have to make sure that when it comes time to sell there will be a buyer. There are ETFs whose trading volume can be low which affects prices. There is also a risk that the ETF will close because the fund was not able to cover administration costs.
Trading and investing in ETFs has similarities to buying a regular stock of a company. It also has its own differences in that you will be buying a basket of assets. There are different kinds of ETFs available and your brokerage will have the well-known ETFs available to buy. ETFs offer the opportunity to buy several assets without having to buy them individually, thus reducing your overall exposure to the market. You can learn more about the stock market by reading one of our free ebooks where you can find in-depth trading information.