ETFs for Dummies: A Simple Guide to Understanding Exchange Traded Funds (2024)

FAQs

What is ETF basics for beginners? ›

An exchange-traded fund, or ETF, allows investors to buy many stocks or bonds at once. Investors buy shares of ETFs, and the money is used to invest according to a certain objective. For example, if you buy an S&P 500 ETF, your money will be invested in the 500 companies in that index.

An ETF, or Exchange Traded Fund is a simple and easy way to get access to investment markets. It is a pre-defined basket of bonds, stocks or commodities that we wrap into a fund and then we list onto the exchange so that everyone can use it.

ETFs or "exchange-traded funds" are exactly as the name implies: funds that trade on exchanges, generally tracking a specific index.

Exchange-traded funds (ETFs) trade on stock exchanges throughout the day, while mutual funds are bought or sold at the net asset value (NAV) at the end of the trading day, and ETFs often have lower expense ratios than mutual funds.

Experts agree that for most personal investors, a portfolio comprising 5 to 10 ETFs is perfect in terms of diversification.

ETFs can be a great investment for long-term investors and those with shorter-term time horizons. They can be especially valuable to beginning investors. That's because they won't require the time, effort, and experience needed to research individual stocks.

Disadvantages of ETFs. Although ETFs are generally cheaper than other lower-risk investment options (such as mutual funds) they are not free. ETFs are traded on the stock exchange like an individual stock, which means that investors may have to pay a real or virtual broker in order to facilitate the trade.

Most ETF income is generated by the fund's underlying holdings. Typically, that means dividends from stocks or interest (coupons) from bonds. Dividends: These are a portion of the company's earnings paid out in cash or shares to stockholders on a per-share basis, sometimes to attract investors to buy the stock.

The low investment threshold for most ETFs makes it easy for a beginner to implement a basic asset allocation strategy that matches their investment time horizon and risk tolerance. For example, young investors might be 100% invested in equity ETFs when they are in their 20s.

When you buy an ETF, where does the money go? ›

ETFs COMBINE THE BEST FEATURES OF STOCKS AND MUTUAL FUNDS

A fund manager then actively manages and invests this money into a basket of different assets and securities – often stocks. You pay the manager in the hope they drive better performance than the market performance.

At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.

ETFs tend to be less volatile than individual stocks, meaning your investment won't swing in value as much. The best ETFs have low expense ratios, the fund's cost as a percentage of your investment. The best may charge only a few dollars annually for every $10,000 invested.

ETFs typically track a specific market index, sector, commodity, or other asset class, exposing investors to a range of securities in a single investment. Their benefits include liquidity, lower expenses than mutual funds, diversification, and tax advantages.

Unlike stock mutual funds, stock ETFs have lower fees and do not involve actual ownership of securities. Commodity ETF: Invest in commodities like crude oil or gold.

ETFs provide broad diversification by only needing to purchase a small number of securities. In contrast, when buying and holding hundreds of individual securities to achieve a similar level of diversification, greater costs are incurred in brokerage and fees – imagine the brokerage to buy 200 individual stocks!

You can put $500 in a stock ETF and $500 in a bond ETF to achieve a diversified two-asset-class portfolio which, though simple, can be a great start toward building a portfolio appropriate for your goals. ETFs can be a simple way to build incrementally toward your long-term plan.

Key differences between stocks and ETFs

Stocks represent a piece of ownership in a publicly traded company. ETFs are a bundle of assets and securities such as different stocks and bonds. A single ETF can contain dozens or hundreds of different stocks, or bonds or almost anything else considered an investable asset.