What are ETFs?
As a CERTIFIED FINANCIAL PLANNER™ and a financial coach, I know that financial terms and vernacular are not as well-known by the general public. In fact I remember starting my journey in the financial planning world and feeling a little overwhelmed at everything I would eventually need to know. Just as I thought I had learned enough in my studies... there were new financial concepts to learn about!
While many Americans are very excited about the possibilities of investing, they still don't know some of the more basic financial concepts. Terms like stocks, bonds, and dividends are something that no one should shy away from. While they can be tricky in application, their meanings should be accessible and known to everyone interested in learning them.
If you're going to be investing your money - shouldn't you know what it's doing in the meantime? I'm someone who believes wholeheartedly in education. Because of this, I've created a small series of blog posts that are dedicated to teaching financial terms to the public! Today we're going to be talking about something that confuses many - the ETF. If you're interested in catching up and reading the other posts in this series, be sure to check out these previous posts:
Remember that any investment has it's risks and rewards. Before you make an investment talk to a financial professional to make sure that the investment aligns with your personal financial goals and needs. This blog post is for information only and is not meant to be a recommendation. Give me a call if you want to learn more!
Without further ado, let's hop right in and talk about what ETFs are!
What is an ETF?
ETF is an acronym that's short for Exchange Traded Funds. To conceptualize an ETF, think of an Easter basket full of goodies. The Exchange Traded Fund is the basket, and within the basket are securities (eggs). Exchange Traded Funds are unique because they can hold all sorts of investments like stocks, bonds, and other commodities and assets. They're actually very similar to mutual funds (with notable exceptions, which we'll get to later).
An Exchange Traded Fund can be structured to follow prices of markets, industries, or even specific commodities. Like a stock, you can buy, sell or trade an ETF all day, and their prices fluctuate regularly (as if they were a stock). Like a mutual fund, ETFs hold multiple assets as a way to diversify your investment.
How ETFs and Mutual Funds are Similar and Different
You may be thinking, "How is an ETF different than a mutual fund? I don't blame you; at first, it can be challenging to differentiate the two as they're both a type of investment that are comprised of other investments. However, the two have some notable differences. For instance, Exchange Traded Funds often have lower investment minimums, making them more accessible to someone just starting out in investing. Exchange Traded Funds can also be bought and sold throughout the day and offer real-time pricing (similar to stocks).
On the other hand, mutual funds are bought and sold only at the end of each trading day, and their price isn't set until the day is over. Overall, these differences mean that an ETF is generally more flexible than mutual funds, which some investors love. If you're really interested in learning more about the differences and similarities between mutual funds and ETFs, I'd suggest meeting with a financial planner or financial advisor representative!
Different Types of ETFs
Like many types of investments, there are various categories of ETFs. Let's go over some of the common types of Exchange Traded Funds…
Commodity Exchange Traded Funds are baskets of investments focused on commodities. These commodities may be raw materials, precious metals, or natural resources. Commodity ETFs may be held one of two ways - physically or more similar to stocks and bonds. In other words you may purchase gold and actually have gold sitting around in a bank somewhere or you have an ETF with precious metals, . Some more examples of Commodity ETFs are sugar, steel, coffee, livestock, or energy.
Similar to commodity ETFs, bond ETFs are precisely what they sound like. A bond ETF is a "basket" of bonds and notes. The great thing about Bond ETFs is that they're generally seen as a relatively risk-averse option for individual bonds. Also, since they're built of bonds, these ETFs receive dividends. Bond ETFs may be comprised of bonds issued by the federal government, businesses, or local governments.
The last primary type of exchange traded fund is called a Currency ETF. A currency is the money that a country and its citizens use. Currency ETFs may speculate and invest in one currency or multiple currencies. While Commodity ETFs are seen as volatile and Bond ETFs are seen as risk-averse, Currency ETFs are seen as simple. However, there's a lot to consider risk-wise when deciding whether or not to invest in a country's currency. History, conflict, trade, and politics all play a role in how valuable a currency may be to an investor.
Currency, bond, and commodity exchange traded funds are the most common types of ETFs. However, they aren't the only ones. Exchange traded funds are also able to be classified as international, stock, and sector. Just like the ETFs listed above, these all are relatively self-explanatory. For example, international ETFs generally invest in foreign country's industries, stock ETFs invest in stocks, and sector ETFs invest in a business or multiple businesses in a specific sector.
ETFs and Risks to Your Financial Plan
Of course, nothing in finance comes risk-free. Exchange Traded Funds, like everything else, contain a certain amount of risk, and an investor should always be aware of the risks they are taking on the front end. Foreign governments, political actions, economic dips, and over-diversification are among some of the most common risks associated with ETFs and have the potential to affect your investment.
The Best Parts About ETFs! (at least to me)
Let's talk about the best parts of Exchange Traded Funds! To start off, ETFs are generally affordable to buy into. While other basket investments, like mutual funds, may have an initial buy-in of $3,000 or more, ETFs may be purchased for as little as $50. This makes them an excellent option for investors who may be new or don't want to invest a ton of money at one time.
Another great part about Exchange Traded Funds is their ability to be bought and sold. So if you're watching the market and you think it's a good time to sell, you can go ahead and make that sale. Also, unlike single stocks, you're able to diversify your investment through multiple stocks, bonds, industries, or even countries. This lowers the amount of risk in your overall basket.
A CERTIFIED FINANCIAL PLANNER™ Can Help You Decide if an Exchange Traded Fund is Right for You
If you'd like to learn more about Exchange Traded Funds or if you'd like to begin investing, please, feel free to call or email to schedule an appointment with me. Together we can create a financial plan that helps you make the most out of your money and investments.
Until next time...this is Melissa Making Cents!
Melissa Anne Cox, CERTIFIED FINANCIAL PLANNER™, is also a College Planning and Student Loan Advisor and Financial Coach in Dallas, Texas.