What is an ETF?



Posted on November 11th, 2022

If you're starting your investing journey, you've likely heard a whole lot of acronyms being thrown around and might be wondering "What is an ETF?" Heck, you might even be invested in one, or a few, without knowing what exactly they are. We're here to change that.

Exchange Traded Funds, or ETFs are one of those things where financial innovation got it right. Think of an ETF like a "basket" of securities from different companies. ETFs can comprise all kinds of investments, from stocks and commodities to bonds. You can then buy a share of this "basket" on an exchange using your e-trading account or via a financial planner- just like you would a regular stock. There are a few reasons why this "basket" is a great idea:

Lower cost

Typically, you can get into these funds at a lower cost, because you can buy just one share, and in some cases, fractional shares.

We don't particularly like paying fees and expenses, and we suspect you don't either. This is another place where ETFs shine, as they typically have fewer broker fees and a lower expense ratio than purchasing individual stocks.

Specific, yet diversified

ETFs are a great way to make broad-based bets in the market. For example: You might want to invest in solar energy because you feel confident it's a growing industry, that will be more important in 20 years' time. It would take a lot of homework to know which company to buy stock in, and even if you did all that work, investing in just one company's stock opens you up to more risk.

Instead, you could buy an ETF that tracks the solar energy industry and comprises all the big solar energy players. This way, you're investing in the industry as a whole, which allows more diversification of risk, than if you picked just one company's stock.

Less volatility

We all know and love the idea of investing in the Total Stock Market, and yup, there's an ETF for that. This way you're betting on the long-term economy as a whole, rather than individual companies or industries. So, you'll still get those market fluctuations, but because of how diverse Total Stock Market Index ETFs are, they're far less volatile than picking individual stocks. This kind of ETF is one of the best ways to build wealth through broad-based market exposure over the long-term.

Increased liquidity

Unlike mutual funds, which are actively managed and only traded once daily after the markets close, ETFs are traded all day on an exchange, hence the name "Exchange Traded Fund". This can be more cost effective and also increases their liquidity.

ETFs can, however, get a little bit convoluted, so it's important to look at the prospectus of the ETF, make sure you understand what it's investing in, how it balances itself, what the actual objective of the fund for which you are buying an ETF in, is set up to do. As with any investment, it's wise to do your own homework and not blindly follow every hot tip you hear at the neighborhood barbecue. That being said, in general, ETFs check all the boxes for what we like to see in investments: lower cost, diversified risk, less volatility, and increased liquidity, which is why we're big fans.

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This blog is for educational purposes only and does not constitute financial advice.

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