Your ETF Questions, Answered
The world of investing loves an acronym. From IRAs to ESOs and ETFs, it’s not easy to keep all the terminology straight.
But, instead of blindly nodding when someone starts mentioning ETFs (Exchange Traded Funds), let’s head back to basics with someone who knows the ins and outs of this investing acronym—namely, Matthew Bartolini, who’s CFA Head of SPDR® Americas Research for State Street Global Advisors. He helps investors understand ETFs on a daily basis, clarifying what goes into this security product.
So, let’s get back to ETF basics with Bartolini’s help.
ETF Basics with Bartolini
ETF stands for Exchange-Traded Fund. While the term ETF is common in investment circles nowadays, Bartolini explained, the product is relatively new—ETFs have only been around since 1993.
Essentially, an ETF is a basket of securities (aka stocks or bonds) that get traded on an exchange. Instead of buying every stock or bond individually, an investor can buy into an ETF, which is a collection of securities in a tidy package.
It’s like buying an album of a various artist’s songs instead of an individual track or singer’s solo record. Investing in ETFs could save some investors time, as ETFs bundle together multiple securities. An investor who opts for an ETF may not spend as many hours researching individual stocks to invest in.
ETFs can be groups of almost any type of security, but investors will find several common types, Bartolini said. Here’s an overview of common types of ETFs:
• Market ETFs often track a major stock market index, like the S&P 500, an index of the 500 top stocks in the US.
• Sector ETFs hone in on a specific theme. Some more recent ETFs include clean energy, smart transport, and Bartolini’s recent State Street favorite, “final frontier,” which invests in space travel.
• Style ETFs are bundled by invest style in the market, which can mean anything from market capitalization to growth or value stocks.
• Foreign Market ETFs invest in international markets, often by region or specific country.
• Bond ETFs group together types of bonds, like municipal, high-yield, and treasury.
• Commodity ETFs deal in commodities, Bartolini explained. For example, a gold commodity ETF holds actual gold.
• Real Estate ETFs are commonly referred to as REITs. It’s like investing in property, without actually owning a building.
Because ETFs can bundle distinct securities, it’s common to find them linked by some kind of theme in order to appeal to investors.
Understanding the Difference Between ETFs & Mutual Funds
Beginning investors may wonder, what’s the difference between ETFs and mutual funds? “Mutual funds have been around for hundreds of years,” Bartolini explained, and like an ETF, mutual funds are funds that hold securities.
When an investor buys into an ETF or mutual fund, they’re buying shares in the funds, which include a portfolio of assets. Both can help diversify an investment portfolio. At a high-level it can be hard to tell these two products apart.
However, here are a few key differentiators between them. Here are some key difference to keep in mind:
• Buying and selling. ETFs are traded on the market, just like an individual stock on the public exchange. If an investor wants to buy or sell an ETF, they can place the order any time when the market is open. However, mutual funds are available to buy and sell just once a day after the markets close. To buy or sell a mutual fund, an investor has to go through the mutual fund company directly, or work with a broker who has an agreement to sell shares.
• Taxes. With both ETFs and mutual funds, investors must pay taxes on capital gains or dividends. However, ETFs tend to have a lower tax requirement. That means, according to Bartolini, that ETFs may at times reduce distributed capital gains each year compared to a mutual fund. Still, different types of ETFs garner distinct tax treatment by the US government.
• Cost. Investors of a mutual fund often need a high investment to get started–anywhere between $1,000 to $10,000. But, in the case of ETFs, investors can get started with a single share.
• Fees. Mutual funds tend to have more active investment strategies, said Bartolini, which can mean higher fees associated with them. Mutual funds might be managed by fund managers, who pick and choose investments in an attempt to outperform the market. Because of their time, effort, and expertise of the fund manager, mutual funds often have higher fees. For some investors, the hand-ons benefits might be worth it, but for others, those fees might cut too close to potential earnings to make sense.
On the flipside, some ETFs are managed more passively, without the hands on, day to day assistance of a fund manager. Certain ETFs follow a set of predetermined “rules” set up at inception. Since there’s less day to day decision making around ETFs, they can come with lower management fees than mutual funds.
Considering how similar they are, it’s natural to confuse an ETF with a mutual fund. However, when it comes to the nuts and bolts of an investing strategy, it’s important to understand the few key, distinct differences.
Downsides of ETFs
So, if ETFs are typically more available to buy and sell on a daily basis than mutual funds—what’s the catch? Like any investment, it has its advantages and its disadvantages. According to Bartolini, one potential downside of ETFs is the sheer number of them on the market.
“There are a lot of products coming into the space all the time,” he explained. “It can be hard to decide what strategy is right for you.”
For that reason, investors might choose to do some due diligence before jumping on an ETF purchase. This could mean understanding what’s bundled into the ETF they’re interested in buying, as well as assessing the risk associated with those stocks and securities. With the proper research, investors may be able to diversify their investment portfolios.
By law, ETFs must disclose all of their holdings, as well as their profits (or losses) over time. And, investors can find that information online. ETF fees are also listed in the shareholder’s prospectus. Interested individuals can find an ETF’s prospectus on the SEC database .
In addition to seeing what they’re made of, it can also be helpful to look into the ETFs historic performance across time. Researching an ETF’s performance may help investors to suss out the level of risk associated with a given ETF
If an ETF is relatively new, investors run the risk of liquidity issues, Bartolini also noted. A newer ETF could have less market interest than an established ETF, which can be an issue in the event an investor wants to sell it quickly.
It can be a good idea to research exactly what securities are being invested in a given fund. Moreover, it can be helpful to understand how a fund is expected to grow. Without this research investors might think they’re investing in one product or industry, when they’ve actually tied their money up in something else entirely.
ETFs with SoFi Invest®
Given the variety of securities out there, ETFs are just one option for beginning investors. When it comes to online investing, there are many ways to get started—from traded funds to government bonds, from cryptocurrency to retirement accounts.
With SoFi Invest®, investors can get started with as little as $1—trading stocks and ETFs for free. SoFi members can choose between active and automated investing options.
Whether pursuing short-term goals or mapping out a long-term financial plan, SoFi can help individuals to invest with ease.
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SoFi doesn’t provide tax or legal advice. Individual circumstances are unique. Consult with a qualified tax advisor or attorney about your specific needs.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.