Exchange-traded funds (ETFs) can help diversify portfolios and manage risk. Whether you need new strategies or you’re considering ways to refine your allocations, understanding ETFs and how they work can be an essential component of modern portfolio management. Here’s everything you need to know about these types of investments, how they compare to other investment vehicles, and how to build an ETF strategy.
What Is an ETF, and How Does it Work?
ETF stands for exchange-traded fund. It’s an investment vehicle that holds a collection of assets, such as stocks, bonds, or commodities, within a single fund. ETFs work similarly to a mutual fund, but they’re bought and sold on exchanges throughout the trading day. Their share prices fluctuate in real time, similar to stocks. ETFs can track specific indexes, focus on particular sectors or commodities, or target companies by size or other characteristics. In today’s market, there is an ETF designed to address a broad spectrum of investment goals.
The Different Types of ETFs
Since ETFs offer a wide range of investment options, it’s possible to tailor portfolios to specific needs or market segments. Here are a few of the different types of ETFs:
- Index ETFs are the most common, mirroring the performance of a specific market index (think S&P 500 or Nasdaq).
- Actively managed ETFs are run by professional managers aiming to beat standard index returns through strategic stock selection.
- Fixed-income ETFs comprise types of bonds, from Treasuries to corporate and high-yield options.
- Industry and sector ETFs focus on specific areas of the market, such as technology, healthcare, and energy.
- Commodity ETFs track the value of commodities, like precious metals, energy, and agricultural products.
- Style ETFs follow certain investment styles, such as growth or value, or target particular asset classes.
- Foreign-market ETFs provide exposure to stocks, bonds, or indices from countries outside the U.S.
ETFs vs. Mutual Funds
Investors commonly use both mutual funds and ETFs, but important differences set them apart.
| Category | ETFs | Mutual Funds |
| Trading Flexibility | Can be bought and sold throughout the trading day. | Traded only once per day after the market closes. |
| Management Style | Typically track an index (passive). | Usually actively managed by fund managers. |
| Cost Efficiency | Generally lower fees due to passive management. | Often have higher fees due to active management. |
| Tax Considerations | Often more tax-efficient with fewer capital gains generated. | May generate more capital gains, leading to higher taxes. |
ETFs vs. Index Funds
ETFs and index funds share some similarities, but there are nuances worth noting. An ETF may track an index, but not all index funds are ETFs; some are mutual funds that do not trade on an exchange. In other words, there’s some overlap between them, but there are also some key differences:
| Category | ETFs | Index Funds (Mutual Fund Version) |
| Trading | Traded throughout the day like stocks. | Traded once daily at net asset value (NAV). |
| Pricing | Real-time market prices. | Settled at end-of-day pricing. |
| Tax Efficiency | May generate fewer capital gains and can be more tax-efficient. | May generate more capital gains and be less tax-efficient. |
| Minimums | Can be bought with the price of a single share. | May require minimum investments. |
| Flexibility | Allow limit orders, stop orders, and intraday trading strategies. | Do not allow intraday trading or advanced orders. |
| Structure Notes | Can be index-based or actively managed, traded on an exchange. | Can track an index but might be a mutual fund, not traded on an exchange. |
ETF Benefits: What to Know When Investing
Investment in ETFs involves buying and selling shares through exchanges, similar to stocks. When selecting ETFs, consider your client’s financial situation, investment objectives, and risk tolerance:
- Investors with longer time horizons may choose ETFs with exposure to higher-growth segments, such as small-cap or technology companies.
- Individuals closer to retirement may prioritize capital preservation, seeking ETFs with more conservative asset mixes.
- The variety of ETFs available can support a tailored approach for nearly any strategy.
Work With a Financial Advisor to Build an ETF Strategy
ETFs can be a valuable tool to help you achieve your financial goals, but like any investment, they carry certain risks. Before investing in any fund, it’s important to review the fund’s prospectus for information on holdings, fees, and associated risk factors.
A professional financial advisor can provide personalized guidance on whether ETFs are a suitable addition to your investment portfolio. At Carson Wealth, our advisors are committed to understanding your complete financial picture to build a strategy that works for you. Match with an advisor today.
FAQs
Are ETFs good for beginners?
Yes, ETFs can be great for beginners because they offer instant diversification across many assets, reducing individual stock risk. They are also easy to buy and sell like regular stocks, making them beginner-friendly.
Is an ETF better than a stock?
That depends on your goals. ETFs provide diversification and lower risk, while individual stocks can offer higher potential rewards but come with more volatility. Many investors use ETFs for steady growth and stocks for targeted gains.
How do ETFs make money?
ETFs make money through capital appreciation, meaning the value of the assets they hold increases over time, and sometimes through dividends paid by the underlying investments. Investors profit by selling their ETF shares at a higher price or receiving periodic dividend payouts.
What is the best ETF to invest in?
It depends on your risk tolerance and investment goals. Popular options for beginners include broad-market ETFs like the S&P 500 or total stock market ETFs, which offer diversification and steady growth potential.
All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful. The views stated are not necessarily the opinion of Cetera and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
Investing in mutual funds is subject to risk and loss of principal. There is no assurance or certainty that any investment strategy will be successful in meeting its objectives.
Investors should consider the investment objectives, risks and charges and expenses of the funds carefully before investing. The prospectus contains this and other information about the funds. The prospectus, which contains this and other information about the investment company, can be obtained directly from the company or from your financial professional. The prospectus should be read carefully before investing or sending money.
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