Chapter 1: Understanding ETFs
IN THIS LESSON
Let’s Learn Some Basics
ETFs, or Exchange-Traded Funds, are investment funds traded on stock exchanges, much like stocks. They are baskets of different types of securities such as stocks, commodities, or bonds, and due to their open-ended structure, generally trade at prices close to their net asset values. The key advantage of ETFs is that they offer diversification similar to mutual funds but with the trading flexibility of stocks, and often come with lower fees and greater tax benefits.
Types of ETFs
Equity ETFs: These ETFs track a specific index of stocks and are the most common type.
Bond ETFs: These focus on fixed-income securities and offer a more stable investment compared to equity ETFs.
Commodity ETFs: These invest in commodities like gold, oil, or agricultural products.
Sector and Industry ETFs: These target specific sectors or industries, such as technology or healthcare.
Key Benefits of ETFs
The benefits of investing in ETFs include diversification, as they allow investors to buy a broad selection of stocks or bonds in a single transaction. ETFs are also cost-effective, often having lower expense ratios compared to mutual funds. Additionally, they offer flexibility since they can be traded throughout the trading day at market prices, unlike mutual funds, which are priced at the end of the trading day. ETFs also provide tax efficiency, as they typically generate fewer capital gains due to their unique structure.
Risks
ETFs come with many different types of risk, including market risk, liquidity risk, and tracking error. Investors should also consider the ETF’s expense ratio, underlying Index, and how well it fits into your investment strategy. All this information is provided within the ETF’s Fund Facts and prospectus, and should be the first documents you read before buying.
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