What is an ETF?
ETF is short for exchange traded fund, which stands for exchange-traded fund. ETFs are exchange-traded investment instruments that track an index, industry, commodity, or asset class. The advantages of ETFs include lower costs, diversity, liquidity and tax efficiency.
How do ETFs work?
ETFs contain a basket of stocks or other assets that reflect the performance of an index. For example, an ETF that tracks the S&P 500 index will proportionally include the stocks of the 500 companies included in the index. An investor can buy and sell the ETF on the stock market and participate in the index's return.
What are the types of ETFs?
ETFs can be divided into different categories based on the assets they track. Some common types of ETFs are:
- Index ETFs: ETFs that track a stock market index. For example, ETFs that track the Dow Jones Industrial Average or the Nasdaq 100 index.
- Sector ETFs: ETFs that track a sector or sub-sector. For example, ETFs that track the technology, healthcare or energy sector.
- Commodity ETFs: ETFs that track a commodity or group of commodities. For example, ETFs that track gold, silver or oil.
- Country or region ETFs: ETFs that track the economy or market of a country or region. For example, ETFs that track China, India or Europe.
- Thematic ETFs: ETFs that follow a theme or trend. For example, ETFs that track artificial intelligence, sustainability or cryptocurrencies.
What are the risks of ETFs?
ETFs also have some risks. These include:
- Tracking errors: It is the difference between the performance of the ETF and the index it tracks. Tracking errors can result from changes in the composition of the index, management fees, taxes and market conditions.
- Liquidity risk: It is the difficulty of trading the ETF. Liquidity risk may arise from market volatility, low trading volume or narrow buy-sell spread.
- Leverage risk: Leveraged ETFs are those that aim to increase or decrease the performance of the index by a certain percentage. While leveraged ETFs offer higher return potential, they also carry higher risk. Leveraged ETFs are not suitable for long-term investing as they are adjusted daily.