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Busting financial jargon: ETFs

Investing 101

Busting financial jargon: ETFs

You may have heard the term ETF used a lot recently. So what's all the hype about? Let's break it down.

 

ETF stands for Exchange-Traded Fund. An ETF trades on an exchange, like the New York Stock Exchange ("NYSE") ("exchange-traded") so it is as easy as buying a stock but, rather than a single stock or bond, an ETF gives you a basket of stocks, bonds, commodities, or other investments ("fund").

 

Key benefits

All in one:  ETFs can be used as a one stop shop to participate in the ups and downs of the market, because one single ETF can hold hundreds or even thousands of stocks or bonds, which provides diversification. Holding your money in many different stocks or bonds is a cornerstone of reducing risk in your investment portfolio.

Easy: Since ETFs trade on an exchange, buying and selling is as easy as buying a stock, and can be done throughout the day (unlike mutual funds, which only trade once a day).

Lower cost: ETFs that track a broad index (an example of a broad index is the S&P 500, which is made up of approximately 500 of the largest US companies) are often one of the lowest cost ways for you to get invested. For example, the average fee of a retail mutual fund is 1.01%, or $1.01 in fees for every $100 invested, while the average asset weighted fee of an ETF is 0.24%, or approximately $0.24 in fees for every $100 invested.

Tax efficient: Generally, ETFs don’t have to realize capital gains (capital gains are profits in the underlying companies) at the end of the year the way some other investments do, which means you might have less tax liability than in a different type of investment.  

Considerations

Not all ETFs are created equal: While most ETF’s goals are designed to give you the same return (minus a fee) as a specific index such as the S&P 500, some ETFs try to outperform the market or give you a different return altogether. Make sure you know exactly what index your ETF is following and what it is trying to achieve.

Don't take the price at face value: The listed fees, generally called expense ratio, does not always reflect the full cost of an ETF. Additional costs may include commissions from buying and selling, and some ETFs with low liquidity, or low trading volumes, can have additional costs.

ETFs are investments, too: Your ETF is only as good as the investments inside and, if the underlying securities lose value, your ETF will lose value too.

Settles in 2 days: When you buy or sell an ETF, you get your money back in 2 days (just like a stock or bond).

Key takeaways:

  • ETFs can be a one-stop-shop to get invested in the markets
  • ETFs have gained popularity because they are considered easy, low cost, and tax efficient relative to other types of investments
  • Not all ETFs are created equal- make sure you know what's inside!

To do:

  • To search for ETFs based on market, size, cost or performance, check out our online trading platform.

LEARN MORE ABOUT OUR FIRM AND INVESTMENT PROFESSIONALS AT FINRA BROKERCHECK.

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