As you seek to expand your portfolio, it’s important to gain a thorough understanding of the different options available. Take exchange-traded funds, for instance. While many consider them to be very similar to mutual funds, the world as it relates to ETFs is far more fast-paced. By incorporating these into your existing investment methodology, you can give yourself a versatile edge. This piece breaks down the nuances of ETFs so that you can have all the necessary details.
What Is An ETF?
- What it is: An exchange-traded fund is a conglomeration of multiple different assets, similar to the approach to mutual funds. By compiling different assets into the fund, you get the benefits of diversity and the safeguards it offers. These funds can then be traded to increase the value overall (or short it in the event of a pre-emptive method of dealing with tax burdens)
- How it works: The unique approach of exchange-traded funds is that they can be traded throughout the day. Similar to stocks, these funds can undergo multiple trades in a short period of time. Generally, a passive approach is taken to the management of this setup since assessments can consider its value as against an index.
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Types of ETFs
There are several different kinds of ETFs, each separated primarily by the nature of the investment. Such types include:
Currency
This type of ETF uses the balance of the currency exchange market in order to achieve desired results. Basically, the fund is used to buy different foreign currencies. These are traded against the American dollar standard for a profit. Some common examples include the Euro, the Canadian dollar, the Australian dollar, and more. Based on the value of those dollars at any given time, a profit can result. For instance, transferring the American dollar to a Canadian dollar, at any given time, profits over 25% (generally). Contrasting this against gains from other dollars, eventually you can convert the currency in a slow-but-steady profitable manner.
Commodity
Referring to its namesake, this type of fund occurs when the investment into an actual commodity. Coal, cobalt, gold, and oil are all key examples of these types of investments. The noteworthy aspect is that commodities are vulnerable to the market in a heavily sociological manner. This means that the values of the greater industry, and thus the wise investment choice, differs regularly. This drastic and notable differential gives the opportunity for significant gains.
Bond
Geared toward those who wish to incur less risk in their investment portfolio, bond ETFs have reasonably safe assets. When investors seek out an exchange-traded fund that focuses on things like bonds through the government or well-established corporations, it shows that security is a high priority. Though you can get steady benefits from this type of investment, the differential in value is far smaller. This means that it can take a more substantial amount of time to achieve the same financial results. However, barring extreme situations, these ETFs are some of the safest investment options.
Industry
Similar to a commodity ETF, those whose assets are placed into a specific industry fall into this category. Within this spectrum, there are a lot of different methods of practice. Examples of the industries include air travel, the banking sector, or things such as technology. By addressing an entire market sector, the investment has a good chance of success provided that arena remains reasonably stable. When looking into industries, there are two main approaches.
The first is to find something with a proven track record that has versatile competitors and place smaller amounts of funds into a large amount of businesses. The small gains and losses of market share reflect in the profits of this type of ETF. Conversely, there is a way to choose a market that is in flux. Within this, the fund can either invest in major players or up-and-comers. When assessing an ETF in this category, be sure you understand which route the fund takes, especially given the passive nature of general ETF strategies.
Inverse
This type of ETF came to popularity after the 2008 market crash. This is largely because those with this type of investment saw the biggest profit out of the incident. These ETFs practice something referred to as shorting. This means the stock is sold when the price is subject to massive deterioration. When the price gets low enough, the fund purchases back the stock for a drastically reduced price. There are other methods of insuring stocks, though ETFs don’t generally deal with this approach. It helps to note that inverse ETFs tend to be more useful in established or necessary industries. Things like essential services are steady, so the asset backing the stock won’t depreciate, just it’s position on the market. Resultantly, you can expect future gains when the market stabilizes instead of just having a cost-effective yet unusable portfolio.
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Difference Between ETFs and Mutual Funds
There are some key differences between ETFs and Mutual Funds, though the uniqueness lies mostly in the trading methods. While ETFs can be traded throughout the day based on small changes in the market index, Mutual Funds can only be traded at the end of the business day. At this time, the value of the Mutual Fund is declared and it sets a price for the exchange. While both have the opportunity to be profitable, Mutual Funds tend to be more time-consuming for those in charge of management and oversight.
Learn about how to choose the best financial advisor for you?
The other difference is the method of management. Typically, the management of Mutual Funds is approached in an active way. This means that there is a professional who is responsible for choosing the investments based on analysis. The fund can be a lot more customized and has the opportunity to deal in conjecture which is not necessarily apparent on the open market. Conversely, an ETF setup uses a passive approach to the overall structuring. This means that the investment locations largely depend on the market and a more algorithmic focus on the index. Requiring much less attention than Mutual Funds, there is also less customization associated with the structure.
Pros and Cons Of An ETF
As with anything else in the finance sector, there are advantages and risks associated with investing in an ETF. By considering them all, and assessing your financial priorities, you can make the best judgement call for your future.
Pros
- Multiple trading opportunities throughout the day
- Ability to work quickly and make rapid decisions
- Versatile selection of ETF types available
- Opportunity to make limited investment for decent payoff
- Chance to choose an ETF with less or more risk
- Generally cost-effective investment opportunity
Cons
- Passive approach to the investment method
- Limited ability to personalize the assets
- Can take a long time to safely see results
- Better suited to long-term investment planning
- Trades exclusively based on the index
- Fewer opportunities for liquifying investment
Prefer investing in something else, check out TFSAs, RRSPs and GICs.
Where Can You Buy An ETF?
A long-standing and well-established investment approach, there are two main ways to purchase an ETF. Currently, considering the state of the world and overall reduced human contact, the more common method is with a digital broker. Conducting business online, these brokers enable you to quickly make the purchase. Everything is done virtually; and, generally speaking, using a passive method. Since you have to pay extra to get active attention to the ETF, buying these is a little bit different.
Typically, if you want to find a broker that will attend to the daily grind behind getting your ETF profitable you would use a personal broker service. These financial professionals deal specifically in this industry and can best assess your goals. Since there is increased opportunity for virtual business, there are some chances to do this without an actual in-person meeting.
These two services represent the different approaches to making the purchase. Another benefit is that they also deal with the sale of the asset. This means that you don’t have to take action or pay close attention to retail the ETF. Instead, in the spirit of passive investment strategies, you empower either the algorithm or the financial professional to make the sale (and necessary purchases).
Final Thoughts
Investment is a wise method of advancing your financial interest. So, now that you know the necessary details of ETFs, you can assess whether that approach is correct for you. Given the vast amount of opportunities for different types of ETFs, there is likely to be a good fit for any investor. By understanding your goals and identifying the corresponding ETF that can help you get there, you can both diversify your portfolio and shore up a quality financial future. Especially useful for busy professionals with limited time for oversight, an Exchange-Traded Fund is a reasonably safe investment for those of all experience levels.
