An ETF, short for exchange-traded fund, is a basket of assets that trades on a stock exchange just like a stock.
Types of ETFs
So what can you invest in with ETFs?
Investment options available to ETF investors are vast.
However, ETFs generally fall within the following categories:
- Stock Market ETFs: Tracks a stock market index like the S&P 500 (SPY), Nasdaq 100 (QQQ), or the Russell 2000 (IWM).
- Bond Market ETFs: Invests in bonds such as U.S. government bonds (TLT), corporate bonds (LQD), municipal bonds (MUB), etc.
- Sector ETFs: Tracks a particular sector of the market such as technology (XLK), healthcare (XLV), or energy (XLE).
- Commodity ETFs: Tracks a particular commodity like gold (GLD), oil (USO), or natural gas (UNG).
- Style-based ETFs: Invests using a particular selection process / filter such as market capitalization (IWC), growth (SPYG), or value (SPYV), etc.
- Region-based ETFs: These ETFs invest in a particular region or country (GXC, INDY, EWG).
- Inverse ETFs: ETFs allow investors to gain when a particular basket of assets decline. For example, if the S&P 500 is down 1% on the day, an inverse S&P 500 ETF (SH) would actually gain 1% for that day.
- Leveraged ETFs: Invests in a stock market index with a particular multiple. For example, if the S&P 500 was up 1% on the day, a 3x S&P 500 ETF (SPXL) would gain 3% on that day.
- Actively Managed ETFs: The managers of an actively managed ETF (ARKK, ARKG) continuously buy and sell assets in an effort to outperform the market.
- Alternative ETFs: While the vast majority of ETFs fall into the categories listed above, there are a few ETFs that are unique. For example, some ETFs invest in the volatility of the stock market (VXX).
Pros of ETFs
- Diversification: Depending on the ETF, an investor can get broad diversification with just one investment. For example, investing in a S&P 500 index ETF provides the investors with exposure to 500 stocks. Imagine trying to buy and manage 500 stocks individually.
- Reduced Risk: While ETF investors most certainly incur risk (e.g. overall market, economic, geopolitical, etc.), individual company risk can be mitigated through diversification.
- Liquidity: Unlike mutual funds, ETFs can be bought throughout the trading day.
- Transparency: ETF prices are reported throughout the trading day and ETF holdings are fully disclosed.
- Tax Efficiency: Unlike with mutual funds, ETFs are taxed only when the investment is sold.
- Flexibility: Like stocks, ETF investors can place limit and stop orders.
Cons of ETFs
- Costs: While it’s not difficult to find a broker with $0 commissions, there is a bid / ask spread (price to buy vs price to sell) and each ETF has its own expense ratio (percent of an ETFs total assets used to cover expenses) ranging anywhere from 0.03% to well above 1%.
- Illiquidity: A thinly traded ETF will tend to have a large bid / ask spread.
How to Buy ETFs
Buying an ETF is rather straightforward.
Simply open an online brokerage account — preferably one that offers $0 commissions.
That’s $0 to buy (or sell) any number of shares of an ETF.
Not sure which broker to go with?
From this list of best online brokers which is based on thousands of investor reviews — Schwab or Fidelity would be a solid choice.
Transfer your money to your online broker.
Then simply login to your new, funded online brokerage account and select which ETF you would like to invest in.
If you want ETF examples / ideas, you’ve definitely come to the right place.
Here are a few to get you started:
- S&P 500 ETFs: Low cost diversification in what is widely considered the U.S. stock market’s benchmark index (also includes many S&P 500 variations).
- Best ETFs Today: Find out how investors reacted to today’s news.
- Best ETFs 1-Year: For a longer term view, see which ETFs investors have bid up over the past year (also includes several other helpful timeframes).