Exchange traded funds (or ETF) have become an important part of the financial markets. They are an investment vehicle that began trading in 1993. They have grown and expanded with many innovations and now can be an important part in helping investors reach their goals. Let’s take a closer look.
ETFs share some characteristics with mutual funds but they also offer significant differences. First, some of the similarities include ETFs, like mutual funds, offer diversification as they are a basket or portfolio of other securities (stocks, bonds, commodities, currencies, etc.). Also, like mutual funds, actively managed ETFs provide professional investment management. ETFs and mutual funds both can offer ways to narrow the investment focus by concentrating the investment in an industry, sector, country, or asset class.
Some key differences are that ETFs trade on the exchanges throughout the day (mutual funds settle after the market close) which means that ETFs’ prices change throughout the day. When buying or selling an ETF, investors can use ‘market orders’, in addition to limit orders, and stop loss orders.
Also, ETF can have lower internal expenses and is usually more transparent. The daily holdings for ETFs are generally published daily while mutual funds are typically report at the end of the quarter.
Here are some examples of ETFs:
Stock Index ETFs – designed to track an index like the S&P 500, Nasdaq 100, Dow Jones Industrial average.
Bond and Fixed Income ETFs – designed to track a type of bond market (treasuries, corporates, municipals, etc.) or a sector (investment grade, high yield, etc.)
Equity Sector and Industry ETFs – focused on an industry such as technology, energy, finance and banking, or retail. These are usually setup to track an index of that sector.
Commodity ETFs – designed to track commodities such as gold, oil, agricultural good, etc.
Style ETFs – designed to follow an investment style or market sector grouped by size. Value or growth are examples of styles. Large cap, mid cap, and small cap are the most common groupings for size definitions.
Foreign Market ETFs – designed to track international indexes for both developed and emerging markets.
Inverse ETFs – designed to move in the opposite direction of an index. These ETFs can be used for hedging or speculation.