The world of Exchange Traded Funds (ETFs) can be daunting at first, but once you get the hang of it, understanding and navigating all these different types is much easier. ETFs are index funds that trade on an exchange like stocks. They’re managed by professional money managers who invest in stocks or bonds to match the performance of a particular market index. The six basic types of ETFs include stock, sector, commodity, bond, currency, and international. Understanding how each performs is of paramount importance before investing in ETFs.
Stock exchange-traded fund (ETF) refers to a security that tracks a specific group of equities. These ETFs are traded on exchanges just like regular stocks and track equities equally as an index does. They may be used to represent individual industries or the entire equities index.
Investors may use stock exchange ETF shares to gain exposure to a collection of equities while keeping their portfolios diversified and at a low cost. These are the most popular types of ETFs, including index funds that invest in stocks. They can track a market or sector index to match its performance, share classes for specific groups (i.e., retail), different bond ratings/investment strategies, etc.
A sector ETF is a pooled investment vehicle that invests in the stocks and bonds of a particular industry or sector, as indicated in the fund’s name. A sector ETF, for example, may track a representative group of energy companies or technology firms.
Sector ETFs have grown in popularity among investors and can be used for hedging and speculation. Even during intraday trading, their high degree of liquidity ensures that the underlying index has very few significant tracking variations.
Some sector ETFs concentrate on U.S.-based equities, while others invest globally to track the sector’s global performance. The underlying index is passively managed. Leveraged sector ETFs that aim to match the underlying index’s return on advancing and declining trading days are also available.
Commodity ETFs are exchange-traded funds that allow investors to gain exposure to individual commodities or commodity baskets in a simple, low-risk, and cost-effective manner. Several ETFs track various commodities, including base metals, precious metals, energy, and agricultural products, allowing investors to create their ideal commodity exposure.
A commodity ETF is either focused on a single commodity—often in actual metal—or on financial derivatives or keeps track of the performance of a commodities index that comprises numerous individual commodities. There are four different types of commodity ETFs. They are Exchange-traded notes (ETNs), Equity ETFs that invest in commodity-related stocks, Futures-based funds, and Physically backed funds.
Bond EFTs invest exclusively in bonds, hence the name. These are comparable to bond mutual funds because they contain different types of bonds, from US Treasuries to high yields. This is done to achieve the best possible returns for their investors. They function similarly to stock ETFs on large stock exchanges. This contributes to market stability by increasing liquidity and transparency when the market is turbulent.
ETFs that invest in bonds pay out interest monthly via a dividend, while capital gains are paid out each year. These dividends are considered income or capital gains for tax purposes. Despite this, bond ETFs’ tax efficiency is insignificant because capital gains do not play as big a role in bond returns as in stock returns.
An international exchange-traded fund (ETF) is an ETF that invests only in foreign-based securities. The emphasis may be worldwide, regional, or country-specific, and it might hold equities or fixed-income securities.
Most ETFs are indexed to a stock index like the S&P 500, but the index may differ significantly from one fund manager to the next. Some funds, especially those with a global presence or those that invest in countries with developed economies, can offer excellent diversification by investing in hundreds of firms.
An ETF that invests in currency is a pooled investment that exposes investors to foreign exchange (forex) or currencies. They enable investors to gain exposure to changes in the exchange rate for one or more currency pairs.
Investors can buy currency ETFs on exchanges in much the same way they would with shares of corporate equities. These funds are usually passively managed and contain only one country’s or basket of currencies’ currencies.
During regular trading hours, currency ETFs make it easy for investors to trade currencies. Thanks to currency ETFs, investors may benefit from structured investment exposure in the foreign exchange market through a managed currency portfolio.
Without knowing what different ETFs have on offer, it can be difficult for an investor to make informed decisions regarding which type may suit them best. Educating oneself on these complex investment vehicles is more important than ever before. Furthermore, numerous risks are associated with investing in any security or asset class, regardless of whether they’re stock-based. And it’s essential to know about all of them.