What are ETFs?￼
ETF stands for Exchange Traded Fund. It is best defined as a combination of commodities, bonds, and stocks—or a few of these. With them you get two of the top advantages: ease of stock trading and the diversification of mutual funds. Good as they are, ETFs are not for everyone. You must evaluate them for yourself and see if they are suitable for you.
Like a stock, you can trade an ETF on an exchange. It allows you to trade a combination of assets without necessarily buying each component individually. This is how it works: underlying assets are owned by the fund provider who creates a fund to monitor their performance. He then sells the shares that make up the fund to investors.
The shareholders do not have ownership to the underlying assets—they only own a fraction of an ETF. Investors still get reinvestments or lump dividend payments for the stocks in the index. ETFs are created to monitor an underlying asset such as a basket of stocks or gold. However, they still trade at prices determined by the market—and these usually differ from the asset. The returns are also different from those of the underlying asset.
The fees of an ETF are generally lower than those of mutual funds. It is one of the things that make them attractive. Investors also love ETFs because of their tax-efficiency advantages. While the popularity of ETFs continues to rise, the available mutual funds are still more. The management structures for these two products are different—mainly passive for ETFs and active for mutual funds. You can, however, get ETFs that are actively managed. You can trade ETFs on an exchange, much like stocks.
Their similarities end with what they represent. Stocks represent a single company while ETFs are a basket of assets. In trading, ETFs are like stocks. But if you look under the hood, you will realize that they are closer to index funds and mutual funds. There are many types of ETFs, and here are the most common. Note that a stock ETF can fall under more than one category.
Stock ETFs: the stocks in this one are designed for long-term growth. Commodity ETFs: a commodity is a raw good such as coffee or gold. With a commodity ETF, a number of these securities are combined to make a single investment. Bond ETFs: these do not come with a maturity date and they generate regular income to the investor. International ETFs: they are less risky and help you diversify your portfolio. Sector ETFs: with a sector ETF, you can invest in certain companies within a specific sector. Pros and Cons of ETFs –
Pros – Diversification, Transparency, Tax benefits –
Cons – Trading costs, Harder to sell/unload, and Risk of ETF closing. If you are looking for brokers, here are some of the best. E*TRADE, Ameritrade, and Interactive Brokers. Before you buy, decide whether you want to be an active or passive investor. Exchange-Traded Funds (ETFs): ETFs are a great alternative to mutual funds. –
Step 3: Reanalyzing Portfolio Weightings – After your portfolio is established, you must assess and rebalance it occasionally.
Market movements can have an impact on your initial weightings. Categorize your investments quantitatively and check the proportion of their values to assess the actual asset allocation of your portfolio. Other factors like your risk tolerance, future needs, and current financial situation may also change. If they change, it may be wise to make some changes to your portfolio. To rebalance, check your underweight and overweight positions.
Step 4: Rebalancing Strategically – Once you know which securities should be reduced, choose the underweight securities that should be bought using the proceedings you get from selling your overweight securities. Before you jump into selling your assets to rebalance the portfolio, make sure you understand the tax implications that come with that. The securities’ outlook is also another important factor.