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What is an Exchange-Traded Fund (ETF)?

How To Invest In An ETF

An exchange-traded fund (ETF) is one of the most important and valuable products created for retail investors in recent years. Maybe you should consider it too, that’s if you understand the risk-reward relationships. Essentially, an ETF is a bundle of securities that trade on an exchange. That means you can buy or sell it like any other stock. The price of an ETF’s shares will deviate throughout the trading day as it is bought and sold on stock exchanges. What investors really need to get started is to open an account with a brokerage firm to start trading. Yes, you read that right, it’s just as simple as that. 

ETFs are a popular choice among investors because they help to diversify your portfolio in a relatively cheap manner. ETFs are in many ways similar to mutual funds. However, ETFs are listed on stock exchanges and ETF shares trade throughout the day just like any ordinary stock. On the flip side, mutual funds are not available on an exchange, and trade only once per day after the markets close. If you prefer a more liquid investment, you know what to choose. 

In short, ETFs offer the best attributes of mutual funds and stocks. It allows investors to have a diversified investment while having the flexibility to trade during stock market hours. With so many benefits from ETF, if used wisely, it could be an excellent vehicle to achieve investors’ investment goals. Not to mention it is also more cost-effective in comparison with mutual funds. But before we invest, there are also different types of ETFs to know.

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Types Of ETFs

A well-known example of an ETF is the SPDR S&P 500 ETF (NYSEARCA: SPY), which tracks the S&P 500 Index. An ETF can own hundreds or even thousands of stocks across various industries. Alternatively, it could also target one particular sector. For example, perhaps you like the electric vehicle (EV) space and are bullish on the sector. If so, you could opt to buy the Global X Autonomous & Electric Vehicles ETF (NASDAQ: DRIV) or iShares Self-Driving EV and Tech ETF (NYSEARCA: IDRV). That’s a good option to consider if you find it difficult to pick winners from losers in the increasingly competitive market. 

There are various types of ETFs available to investors depending on your preference. Be it for income generation, speculation or hedging, There will be one that will suit your needs and appetite. It’s also important to note that these ETFs aren’t categorized by either passive or active management, but rather by the types of investments held within the ETF.  

Stock ETFs

These comprise stocks and are usually meant for long-term growth. By doing so, investors can gain exposure to a pool of securities and limited company-specific risk associated with single stocks. While typically less risky than holding individual stocks, they carry slightly more risk than some of the others listed here, such as bond ETFs. This instant diversification comes in a simple, low-cost, and tax-efficient tool that can be accessed through most online brokerages.

Alternatively, you could also manually construct a stock portfolio on your own by purchasing a few single potential stocks that you deem highly potential. This way, you have greater flexibility and could custom-made the portfolio according to your risk appetite. Do this if you think you have the discipline and time to research individual stocks. But what if you have the habit of splurging on any stocks that are trending in the stock market today? In that case, perhaps you are better off sticking to an actual stock ETF.

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Industry ETFs

The U.S. stock market is divided into 11 sectors. And each is made up of companies that operate within that sector. Industry ETFs provide a way to invest in specific companies within those sectors. It could be technology, financial, or biotechnology sectors. These categorizations may give you a general idea of which sector to invest in. But that’s not always enough. For instance, many investors like tech. And we know tech is a broad sector. As a result, investors can dive deeper into specific niches. Earlier in the article, I have mentioned electric vehicle ETFs. But there are other ETFs within the tech space as well. For example, if you like semiconductors, you might consider the VanEck Vectors Semiconductor ETF (NASDAQ: SMH).

These can be especially useful if you want to keep track of any particular niche or industry. Say, you are bullish in the marijuana space today. And that’s understandable as the Biden administration has a friendlier policy towards the industry. As the policy is favorable for the space to expand, the demand for ETFs in this space may be higher. For instance, AdvisorShares Pure Cannabis ETF (NYSEARCA: YOLO) may be an option to consider. 

Bond ETFs

Unlike individual bonds, bond ETFs don’t have a maturity date. Hence, the most common use for them is to generate income yield to investors. These payments come from the interest generated by the individual bonds within the fund. Perhaps you are in your retirement age, or you don’t feel comfortable with the swings in prices. If that’s the case, bond ETFs can be an excellent, lower-risk complement to stock ETFs.

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International ETFs

International stocks can refer to stocks of companies outside the U.S. They can be a great way to diversify your portfolio. These foreign stocks, along with U.S. stocks and bonds, can be an excellent mix to your portfolio. And that’s one of the reasons why global institutional investors have been increasing their allocation to stocks from emerging markets like Asia. 

Ray Dalio, the founder of Bridgewater Associates, sees the need to have a significant portion of its portfolio in Chinese assets for long-term diversification and shorter-term tactical trading purposes. Of course, you may have a different opinion of him. Whether you are bullish on India, Japan, or any other country, you can almost certainly find an ETF that invests in a specific country. Investing internationally has become very convenient these days, don’t you think?

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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