An exchange-traded fund (ETF) is a fund traded on a stock exchange. ETFs can include any assets types, like equities, real estate investment trusts (REITs), bonds, commodities, and even forex. One fund usually has several assets. Unlike mutual funds or an index fund, ETFs can be traded like stocks – all day around when the stock market is open.
Key takeaways on ETF trading
- A good investment vehicle to build a diversified portfolio.
- ETFs are liquid and generally come with low expenses.
- Depending on your risk tolerance you can choose from a variety of different types of ETFs.
- The net asset value of an ETF represents the value of all the assets held by the fund, minus any liabilities, and dividing that by the number of outstanding shares in the ETF.
- Unlike with a mutual fund, intraday trades, stop orders, limit orders and short selling are all possible with ETFs.
Exchange-traded funds are one of the most popular ways for investors to build a diversified portfolio, as ETFs hold hundreds of asset classes and have exposure in a variety of investments. Depending on your risk tolerance you can choose from a wide spectrum of ETFs.
For a beginner, it can be very difficult to decide when to buy ETFs. And don't forget that ETFs can experience volatility over the short term. Here is our guide on when to buy ETFs.
So think about your financial goals, whether you want to learn how to play the market or sit back and let the fund work for you for a lower but stable dividend. ETF trading also carries risks. If you have a higher tolerance for risk, you can try leveraged ETFs, for instance.
If you’ve decided to invest in exchange-traded funds, choose ETFs that suit your goals and risk tolerance. Decide how much money you want to invest and in what types of assets, and what your investment objectives are:
- A multi-asset exchange-traded fund could be a good point to start if you are a novice investor.
- A more risky portfolio would mean for instance 20% invested in bonds, and 80% invested in stocks.
- A more conservative approach would be 60% in bonds and the rest in stocks and other assets.
An ETF’s risk is based on its trading strategy and underlying securities and is influenced by market volatility.
With time you can rebalance your portfolio if it deviates from the financial targets you have set for yourself. You can rebalance at predetermined time intervals, or when your allocations have shifted from your desired portfolio mix. You can rebalance by selling and buying specific investments or allocating funds towards stocks or bonds, depending on your risk tolerance. Rebalancing is not free; it may involve trading fees and possibly taxes on capital gains.
You can invest in ETFs through a brokerage account. If you want to know where to get started, scroll through our current the list of the best ETF brokers that our experts have put together. Some brokers run their own ETFs, so check out if that is a fund you might be interested in.
Key steps to start your ETF trading
- Understand the costs of ETF trading, the annual fees, and possible taxes on capital gains.
- Define your ETF investing strategy and determine what type of ETF you want to invest in.
- Open a trading account at a broker and buy shares in an ETF.
Different types of ETFs
- A multi-asset ETF allows you to diversify your portfolio into different asset classes such as stocks or bonds. More cautious investors will have more bonds in their portfolios, while aggressive investors will focus more on stocks.
- Basic Index ETFs hold investments that match the returns of a financial index, such as the S&P 500.
- Sector ETFs focus on specific sectors or industries.
- Commodity ETFs focus on a commodity like gold. You don't actually buy the physical item, but track the price of the underlying commodity.
- Foreign market ETFs target a particular region of the world.
- An actively managed ETF is a fund that has a manager making decisions on the underlying portfolio allocation. Bear in mind that active management comes with higher fees.
- A currency ETF allows you to gain exposure to foreign currencies without actually doing complex transactions.
- Bond ETFs are a type of exchange-traded fund that exclusively invest in bonds.
- Leveraged ETFs are for people with a higher tolerance for risk, experienced investors, and are designed to offer leveraged daily returns on underlying indexes and assets. However, they are not suitable for anything other than day trading.
- Inverse ETFs perform well when the index they track is down.
- Socially responsible ETFs focus on companies that support environmental and social issues.
What else do you need to know about ETFs?
Want to know more before deciding which is the best ETF for you? Check out these articles to deepen your knowledge:
- What is the difference between mutual funds and ETFs?
- What is the difference between US and EU ETFs?
- What does an ETF portfolio mean?
- What is an ETF expense ratio?
- How to invest in ETFs?
- How liquid are ETFs?
- How to buy Vanguard ETFs?
- How to buy iShares ETFs?
- What are sector ETFs?
- What is passive investment?
- Are US ETFs only available for US residents?
- How to choose your ETF
How can I buy ETFs?
For more info, click here to learn how to buy ETFs online.