Many people mistakenly think that exchange-traded funds (ETFs) are the same as mutual funds. While they share some similarities, they are quite different.
The first ETF in the U.S. was introduced in 1993 to track the S&P 500 Index. This ETF, known as the SPDR S&P 500 ETF Trust (SPY), is still around today and is the largest ETF with about $500 billion in assets.
ETFs are investment vehicles that operate like mutual funds but trade like stocks. They can invest in a wide range of securities, from a few dozen to thousands. For example, ETFs that track broad indexes like the Wilshire 5000 invest in thousands of stocks, while sector-specific ETFs might only hold a few dozen.
Unlike mutual funds that trade once a day after the market closes, ETFs trade on exchanges throughout the day, just like stocks. According to the U.S. Securities and Exchange Commission (SEC), ETFs allow investors to pool their money into a fund that invests in various assets like stocks, bonds, or other securities.
ETFs have several advantages and disadvantages due to their structure. They are designed to track a large group of securities or even individual commodities. For example, S&P 500 ETFs track the S&P 500 Index, while gold ETFs follow the price of gold and related stocks. ETFs must be registered with the SEC and comply with the Investment Company Act of 1940.
ETFs are bought and sold on stock exchanges and have ticker symbols and continuous price updates. For instance, the SPDR S&P 500 ETF Trust is traded under the symbol SPY. The number of shares in an ETF can change daily to keep its market price in line with its holdings. This means that financial institutions continuously create and redeem shares.
When you buy $100 worth of an ETF, you own a piece of all the holdings in that ETF. For example, the SPDR S&P 500 Trust contains 503 stocks, so your $100 would represent a small fraction of each.
There are thousands of ETFs with different characteristics, based on the types of assets they hold, their investment strategies, and the industries or sectors they focus on. The two largest providers of ETFs by assets are BlackRock and Vanguard. BlackRock offers over 400 ETFs, while Vanguard’s list is smaller but includes many large funds for individual investors.
Stock ETFs consist of a collection of stocks that follow an index, like the S&P 500, Wilshire 5000, or Russell 2000. These ETFs are diversified and generally less volatile than owning a few individual stocks. Bond ETFs hold bonds, providing exposure to this asset class. The largest bond ETF is the Vanguard Total Bond Market ETF (BND), which includes U.S. T-Bills, Treasury bonds, corporate bonds, mortgage-backed securities, and agency bonds. Other bond ETFs may focus on specific types of bonds, such as municipal bonds.
Although individual bonds have maturity dates, ETFs do not, making them useful for generating income through interest payments. Commodities like gold, silver, oil, and agricultural products can diversify a portfolio but are often difficult and risky for individual investors to manage. Commodity ETFs offer a way to invest in these assets without physically owning them.
International ETFs provide exposure to foreign markets, which can diversify a portfolio and potentially improve returns. These ETFs track regions, specific countries, or international equities. For example, the iShares Core MSCI EAFE ETF (IEFA) offers broad exposure to stocks in developed markets outside the U.S.
The U.S. market is divided into 11 sectors, each representing businesses in specific industries. Sector ETFs allow investors to focus on these sectors, which can be beneficial during different economic cycles. For example, the Energy sector may perform well when oil and natural gas prices are high. Industry ETFs focus on specific industries within a sector, like Aerospace & Defense within the Industrial sector.
One of the newest types of ETFs is the Bitcoin ETF, which invests in the cryptocurrency. The SEC recently approved several spot Bitcoin ETFs, allowing Bitcoin to be traded through brokerage accounts. The largest Bitcoin ETF currently is the Grayscale Bitcoin Trust (GBCT).
ETFs are widely available through most brokerages and investment platforms. Choosing the right one depends on personal preference, as there are differences in the number of offerings, accessibility, platform features, and fees. While ETFs are usually traded without commission, some platforms may charge access fees. Some platforms also offer portfolios of ETFs, simplifying the investment process for individuals.
In summary, ETFs provide a way to invest in a variety of securities without buying them individually. They allow for smaller investments, offer instant diversification, and are generally low-cost, making them a good option for many people.