What is an Exchange Traded Fund (ETF)?
Exchange Traded Funds (ETF) are investment funds that are traded on stock exchanges and they hold assets such as bonds, equities or commodities.
There are three types of ETFs, Equity ETF, Bonds ETF and Commodity ETF. To understand how investing in ETFs work, imagine ETFs as baskets holding actual securities. A bonds basket will therefore contain government and corporate bonds, an equity basket will contain stocks from various companies belonging to specific sector and a commodity basket will contain commodities such as gold, silver or crude oil.
Therefore, when an investor invests in a gold ETF, he is not actually buying gold itself, but instead he is buying shares of the big basket of gold. These shares can then be traded on exchange for profit just like stocks.
Properties of Exchange Traded Fund (ETF)
1. ETFs are created to behave the same way as a specific index or a collection of different securities. This means that ETF will track or move in tandem with the security that it is designed to follow.
2. ETFs inherited traits from both index fund and stocks. Similar to Index Funds, most ETFs are passively managed, diversified and low cost and similar to stocks, ETFs can be traded on exchange.
Index Fund: An Index Fund is a type of mutual fund with a portfolio constructed to match or track the components of a market index.
Market Index: A Market Index is an aggregate value produced by combining several stocks together and expressing their total values against a base value from a specific date. Market Indexes are used to represent an entire stock market and thus can be used to track the market’s changes over time.
Advantages of Exchange Traded Fund (ETF)
ETFs give investors access to a broad range of markets that will otherwise be extremely difficult for investors to gain access to due to high cost.
Since ETFs are made up of a large number of underlying securities, investors investing in ETFs will receive a diversified exposure in one single ETF investment.
Similar to stocks, ETFs are listed on the stock exchange which gives investors the flexibility to buy and sell them anytime during trading hours.