ETFs: What are the Basics?

What Are ETFs?

ETFs–also known as exchange-traded funds–are investment vehicles comprised of stocks, bonds, and other assets that are traded on an exchange. ETFs combine a number of different assets into one vehicle, which are then divided it into multiple shares. By doing so, ETFs allow for a relatively straightforward avenue towards building a diversified portfolio that will help build and safeguard your wealth.

ETFs can represent different sectors, commodities, geographies, or fixed income assets, among other categorizations, giving investors plenty of options to choose from. Just like stocks, ETFs are traded throughout the day, and their prices fluctuate accordingly.

You can use the TipRanks’ ETF Screener to review and compare over 3,000 different ETFs, filtering them by asset class, price target, and dividend yield, among other categories.

How to Choose an ETF

With so many different options, deciding which ETF to invest in can be an overwhelming process. However, the fundamentals, like any investment decision, can be broken down by looking at the risk versus reward of specific asset classes.

In essence, ETFs are only as strong as their underlying assets, and here you have enormous freedom to choose the type of investment you believe is most likely to generate value. This can be a certain sector or industry, large-cap companies listed on a particular stock exchange, a particular commodity, or even by finding a specific asset manager responsible for overseeing the ETF.

Acquiring ETFs allows you a relatively straightforward entry-point to invest into asset classes that are often unattainable for small-scale investors, such as real estate. There are different levels of diversification that you can attain through the purchase of an ETF, either by attempting to take advantage of a promising sector or by spreading your exposure over multiple types of assets.

Not surprisingly, there are different levels of risk, as well. You can purchase a conservative ETF which is built on bonds, or a riskier one that is composed of small-cap growth stocks. The choice depends on your risk appetite, and the type of assets you believe represent the best opportunities for growth.

What are the Advantages and Disadvantages of an ETF

There are a number of different pros and cons that are part of the ETF equation. The primary benefits are:

• Diversification: ETFs allow investors to enjoy the benefits of a specific industry, index, or commodity, without being reliant on one particular company or product.
• Easily tradeable: ETFs function like stocks, and can be bought and sold like other individual equities. Mutual funds, on the other hand, can only be bought once a day after the close of trading.
• Low investment threshold: There are lower-priced ETFs, which are attainable even for small-scale investors.
• Lower management fees: Most ETFs are passively managed, meaning that the management fees tend to be lower.
• High degree of transparency: The basket of goods making up ETFs are available for review on a daily basis, whereas mutual funds generally share updates on a less frequent basis (i.e. monthly or quarterly).

There are, however, some disadvantages for ETFs as well. These include:

• Management fees: While they are generally lower than mutual funds, they are still present. The more active funds will tend to have higher expense ratios, which is the cost of owning a fund.
• Lack of liquidity: Depending on their popularity, some ETFs are more seldomly traded. This could mean that your ability to sell your holdings instantaneously, as you would for most stocks, will be limited.

Conclusion: ETFs and Building Your Wealth

Because they represent diversification by definition, ETFs can be a powerful tool to build and safeguard your wealth. Investing in an ETF will shield you from the risk that losses from a single company will sink your portfolio, and will allow you to enjoy the benefits of multiple holdings from a single investment.

As with every other type of investment, the earlier you are able to start and the longer you are able to keep your monies invested the better off you will be. This is because of the magic of compound interest, whereby the interest you have earned will start to create its own returns. (You can experiment with the TipRanks’ compound interest calculator to understand how this works in practice.)

Like every investment, looking at the data can help you find the best investments with the most promising returns. TipRanks’ ETF center provides you with advanced tools to understand the risks and rewards of thousands of ETFs on the market, helping guide you towards the best investment option for you.

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