The exchange-traded fund or ETF is a type of security that shares similar characteristics with a mutual fund. The primary difference is that you can’t trade mutual funds on the stock exchange, unlike with ETFs. The ETFs are a bunch of securities that are used to track the underlying indexes. The six most common types include equity funds, commodity funds, fixed-income funds, real estate funds, currency, and specialty funds.
A simple explanation of the process is this:
The fund issuer owns the underlying assets. They will then design a fund that allows them to track the performance of these assets to sell the shares to interested investors. As an investor, you tend to own a portion of the ETF, but you have no ownership of the underlying assets.
An ETF is a great way to start if you want to invest in the stock exchange. It is particularly ideal for young investors and beginners who might be intimidated by trading in the open market.
Beginners often mistake ETF with the index fund. Although they both offer outsiders an opportunity to invest in several securities, there are key differences between them:
- The ETF is listed while the index fund is not
- The index fund requires a minimal amount to trade while the ETD does not
- You can trade ETF commodities throughout the day while index funds have fixed schedules for trading
Why You Should Invest in ETFs
There are several benefits to choosing ETFs compared to index funds or as your stock exchange starter pack.
- You do not need a large amount to invest — As already mentioned, index funds require a minimum investment amount, which may be around $3,000. However, there is no set amount for the ETF. You only pay for the purchase price of each stock being traded. For instance, if each share is priced at $10 and you bought ten shares, your initial investment is $100. However, you do pay a brokerage fee unlike with index funds, which do not charge any transaction fee.
- Variety of choices — Another benefit of investing in ETF is the wide range of options. You can trade in currency, real estate, equity, and commodity funds. You may find something you are really interested in and choose to concentrate on that area. For example, there are as many as 2,200 ETF assets in the US stock market. In Australia, there are about 200 ETFs. You can participate in any one of these assets to grow your fund.
- Minimal risks — Of course, risks are part and parcel of open market trading. However, a majority of the ETFs are very liquid, which is good news if you are only starting with limited investment capital. Also, you can trade all throughout the day, which means you can dump the shares at the first sign of trouble and not wait for the market to close.
- Low management fees — In general, the ETF has a lower expense ratio compared to other financial instruments. Yes, there is a transaction fee but a good number of brokers, for instance, will offer a commission-free service. Also, tax efficiency is one of the characteristics of ETFs compared to the mutual fund or the index fund.
Lastly, ETF trading is not straightforward because there are other instruments that will make the process more exciting for any young investor. For instance, a leverage ETF raises the stake as they will multiply the results by 2-3 times. Meanwhile, the inverse ETF works exactly as it sounds. By participating in this exercise, you will trade in the opposite direction to the performance of the market or asset.