Investing Basics: ETFs


[MUSIC PLAYING] An Exchange Traded Fund or
ETF is an investment fund that trades like a stock. ETFs, like other types
of funds, pull together money from investors
into a basket of different investments,
including stocks, bonds, and other securities. By spreading the fund’s money
into different securities, ETFs can generally provide
investors with diversification, which can help balance risk. And because ETF shares are
traded on a stock exchange, they’re bought and
sold like stocks and usually incur commissions
and other related fees. Just like there are a
variety of mutual funds, there are a variety
of different ETFs, each with different objectives. Some ETFs invest in a
variety of stocks and bonds. Some replicate the
performance of a stock index, like the Dow Jones Industrial
Average or S&P 500, and others tracked
the performance for a particular market
sector, like technology or pharmaceuticals. However, different ETFs
offer different amounts of diversification. For example, ETFs that focus
more on specific sectors typically offer
less diversification than those that are designed
to replicate an index. Let’s look at an example
of investing in an ETF. Suppose an investor wants to
make a diversified investment that is designed to mirror the
performance of a major stock index like the S&P 500. After researching
different ETFs and finding the one he wants based
on his objective, he purchases shares of
it through his broker, just like he would
an individual stock. Now that he owns
shares, the investor has a stake in each of the
fund’s basket of investments, while only having
to purchase one ETF. Participating in the wide market
with only a single purchase instead of multiple purchases
can save an investor research and analysis time. So how can an investor
potentially achieve a positive return from the ETF? Similar to a stock, he can
earn a return two ways– a rising ETF market
price and dividends. Typically, if the value of the
ETF’s investments increases, so does its price. If our investor purchased
a hypothetical ETF at $40 and a year later it
was selling for $50, our investor could
profit $10 per share by selling his position. Of course, if the
ETF’s price dropped, our investor would
have lost money if the position was
sold at the lower price. Because many ETFs are
traded on a stock exchange, they can be bought and
sold throughout the day. However, not all ETFs
are widely traded, which can cause difficulty
when trying to fill orders. Now, compare this
to a mutual fund. Most mutual funds are
only priced and traded at the end of the day. Separate from changes
in price, our investor could potentially gain income
if the ETF pays its investors a dividend, which is a payout
of part of the fund’s earnings and capital gains. Not all ETFs pay dividends. Many Instead reinvest earnings
into the fund’s holdings. One of the ways to tell
whether a fund pays dividends is to look at what’s
called its dividend yield. This yield is the amount
that the fund pays out compared to the current
market price of a share. ETFs have other
attractive qualities. While most mutual funds require
a minimum investment, which can be substantial,
an ETF investor can just buy a single share
plus any commissions and fees. Also because most ETFs
aren’t actively managed, they typically have
lower management fees than mutual funds. There is a wide variety of ETFs
that attempt to track assets, like corporate bonds,
stocks in remote countries, commodities, and even currencies
among many other investments. While these assets carry unique
risks, the ETFs that track them offer investors a
practical way to analyze and potentially
find opportunities in a number of markets. Want to learn more about
ETFs and other investments? Continue exploring
premier education brought to you by TD Ameritrade.

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