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

FAQs

What is a simple way to explain ETF? ›

ETFs or "exchange-traded funds" are exactly as the name implies: funds that trade on exchanges, generally tracking a specific index. When you invest in an ETF, you get a bundle of assets you can buy and sell during market hours—potentially lowering your risk and exposure, while helping to diversify your portfolio.

An exchange-traded fund (ETF) is a basket of securities that trades on an exchange just like a stock does. ETF share prices fluctuate all day as the ETF is bought and sold; this is different from mutual funds, which only trade once a day after the market closes.

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

ETFs, the most common type of ETP, are pooled investment opportunities that typically include baskets of stocks, bonds and other assets grouped based on specified fund objectives. Unlike ETFs, ETNs don't hold assets—they're debt securities issued by a bank or other financial institution, similar to corporate bonds.

Before purchasing an ETF there are five factors to take into account 1) performance of the ETF 2) the underlying index of the ETF 3) the ETF's structure 4) when and how to trade the ETF and 5) the total cost of the ETF.

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.

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.

Investing in the stock market is one of the most effective ways to generate long-term wealth, and you don't need to be an experienced investor to make a lot of money. In fact, it's possible to retire a millionaire with next to no effort through exchange-traded funds (ETFs).

How long should you hold an ETF? ›

Holding an ETF for longer than a year may get you a more favorable capital gains tax rate when you sell your investment.

Diversification: A well-diversified portfolio should include ETFs that cover different asset classes (stocks, bonds, commodities, etc.), sectors, industries, and geographical regions. This spreads risk and reduces the impact of any single investment on the overall performance.

Stock-picking offers an advantage over exchange-traded funds (ETFs) when there is a wide dispersion of returns from the mean. Exchange-traded funds (ETFs) offer advantages over stocks when the return from stocks in the sector has a narrow dispersion around the mean.

ETF shares trade exactly like stocks. Unlike index funds, which are priced only after market closings, ETFs are priced and traded continuously throughout the trading day. They can be bought on margin, sold short, or held for the long-term, exactly like common stock.

Consider an ETF if:

Intraday trades, stop orders, limit orders, options, and short selling—all are possible with ETFs, but not with mutual funds. You're tax sensitive. ETFs and index mutual funds tend to be generally more tax efficient than actively managed funds.

Mutual funds and ETFs may hold stocks, bonds, or commodities. Both can track indexes, but ETFs tend to be more cost-effective and liquid since they trade on exchanges like shares of stock. Mutual funds can offer active management and greater regulatory oversight at a higher cost and only allow transactions once daily.

Exchange-traded funds (ETFs) are a wonderful way for beginners to start their investing journey. Once you understand the basics, you'll find this a simple and convenient strategy to invest your savings and build long-term wealth.

Exchange-traded funds (ETFs) are SEC-registered investment companies that offer investors a way to pool their money in a fund that invests in stocks, bonds, or other assets. In return, investors receive an interest in the fund.

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.