ETFs are a word you are likely starting to hear more and more, especially with the recent rise of robo-advisors and automated investment platforms. But what does it stand for, and more importantly, what good does it actually do?
What is an ETF?
ETF stands for Exchange-Traded Fund, and it is simply a pool of stocks that are grouped together under one package. This package is then traded on a stock exchange, like a stock, with its own ticker symbol.
So say you believe in the future of a specific niche, maybe cybersecurity. You’ve heard of a couple of cybersecurity companies and want to invest, but you’re worried about sinking all of your eggs into one basket, or overallocating to one company. This is where ETFs can come in handy. ETFs are offered on virtually any asset class, and generally in both directions (perhaps you are bearish on a particular industry). This gives you the ability to diversify across a number of companies, and you can find ETFs on almost any traded commodity.
ETFs are very similar to mutual funds in the sense that they’re a fund, have a manager, and generally track a specific index. They were first introduced in the US in 1993.
As with anything in the investing world, there are drawbacks to consider.
Similar to their cousins, mutual funds, a lesser known fact about ETFs is that they do in fact have fixed fees associated with owning the position. These are called expense ratios. These are generally much lower than mutual funds, and ETFs do not have the other fees, such as 12b-1, that mutual funds carry.
While ETFs are generally extremely liquid, you’ll want to check volume and bid-ask spreads. This especially applies for any that are off-the-beaten-path, such as leveraged ETFs. This will save you when it comes time to sell.
ETFs, and mutual funds alike, are legally required to provide a prospectus. A prospectus is a document entailing all of the securities the fund holds, with percentage allocations. You’ll always want to review this before acquring a position, and it is a good idea to check it occasionally while holding.
Overall, ETFs are a wonderful tool for gaining exposure to markets while reducing company-specific risks along the way.