Exchange traded funds (EFTs) 101

Exchange traded funds (EFTs) 101
Table Content
What are exchange traded funds?
How do ETFs work?
Advantages of investing in ETFs
Pros of investing in ETFs
Cons of investing in ETFs
What’s the difference between an ETF & a mutual fund?
Three common types of ETFs
Steps to start your trading journey

An exchange-traded fund, aka ETF, is one of the most common choices for beginner investors who want to kick off their trading journey with a diversified product. Let’s dive into what ETF means and how it differs from other investments. We’ll also guide you through some of the most typical ETFs you’ll come across in the markets and even show you how to invest in ETFs step by step. YALLA.

What are exchange traded funds?

Let’s say you’ve been considering investing in pharmaceuticals but are unsure which pharma company to invest in. With EFTs, you don’t have to choose just one. A pharmaceutical ETF could include shares from many pharma companies, giving you a more comprehensive range of investments in this industry. It also lowers your risk of betting on only one company. With an ETF, if the value of one company drops, it could be offset by the value of another company in the same basket going up. More on that below.

So, what is an ETF exactly? An exchange-traded fund, or ETF, is an index fund that acts as a group of securities. Think of an ETF as one basket holding multiple securities, such as stocks, bonds, commodities or even currencies. 

That’s why investing in ETFs is a great way to diversify your portfolio—a single ETF is made of several assets instead of just one. You can even buy an ETF that holds thousands of companies. Want to know more? Let’s dig deeper.

 

read more: how to invest in stocks online
 

How do ETFs work?

  • An exchange-traded fund exists thanks to a so-called fund provider. That’s someone who sets up an ETF so investors like you can hold stock in the basket.
  • Like a stock, each ETF has a unique ticker that helps tell it apart from other positions in the market. For example, the ticker for the Vanguard Value ETF is VTV, and the Shares Russell 2000 Value ETF’s ticker is IWN.
  • You can buy ETFs and sell them on an exchange at any time throughout the day, just like stocks. The price of each ETF changes based on supply and demand.
  • You could also earn dividends from investing in ETFs. Investors receive the dividends either monthly or at some other interval, depending on the ETF and its construction.
  • Some ETFs, such as the Nasdaq Composite, are constructed to track index funds. Others are pegged to specific industries, such as electric cars, various stock market segments, and even businesses with huge market capitalization, aka the big players.

And that’s how ETFs work, in a nutshell.

Advantages of investing in ETFs

Diversification & lower risk: When you buy an ETF share, you invest in securities belonging to multiple companies. You could even invest in securities spanning different industries, such as cybersecurity, automotive, energy, and tourism, in one ETF. That makes investing in ETFs a pretty diversified type of investment and even lowers risk.

When you invest in ETFs, the performance of your portfolio isn’t tied to the risks of a single company or industry sector. So, we can say that the main advantage of investing in ETFs is a lower risk of volatility. Although, there’s never a guarantee that you’ll make or lose money on your ETF.

Are these all of the advantages? What about some disadvantages? Don’t worry; we’ve got you covered with those, too. 

Pros of investing in ETFs:

  • Flexibility: ETFs can be bought and sold during trading hours, just like stocks. You can buy an ETF in the morning, sell it at lunch, and repurchase it later that afternoon if you’re a day trader. 
  • Versatility: ETFs also give you access to a wide range of stocks, bonds, and other assets at a low cost. What’s more, you can employ many strategies with each ETF, making them exceptionally versatile. 
  • Simplicity: ETFs make stock investment a bit more straightforward. They enable you to mirror the market’s long-term performance, which has historically been positive. 
  • Fluidity: ETFs are more fluid than mutual funds (easier to purchase and sell). With a few taps, online brokers make buying and selling ETFs simple. 
  • Hedging: You can also use ETFs to hedge your position (offset the losses in your existing asset by taking an opposite position in a related asset). One strategy is to trade inverse S&P 500 ETFs, which always move opposite to the stock market. 

Cons of investing in ETFs

Now let’s take a look at a few disadvantages too:

  • Because they’re made out of a diverse range of stocks, ETFs don’t entirely give you the same higher returns as individual stocks. Most ETFs are tied to a benchmarking index, meaning they’re often constructed, so they don’t outperform that index. If you’re looking for a “wow” outperformance (which comes with more risks), you might want to try other products instead. 
  • You can buy or sell ETFs throughout the day, but that doesn’t always make them easy to trade. Some ETFs that focus on a niche or obscure areas may have fewer buyers and sellers, making it trickier to sell them at the price you want.
  • ETFs are not ideal for every investor. They’re most appropriate for folks who have a sizable chunk of money but aren’t sure how to invest it. For the time being, those folks can invest in ETFs to potentially generate a return while waiting for their funds to be correctly deployed. Additionally, choosing the appropriate ETF requires a more robust knowledge of the financial markets than most retail investors have.
     

read more: top 10 reasons to download the amana app

 

What’s the difference between an ETF & a mutual fund?

You’ve probably heard of a mutual fund investment and wonder if these two things are the same. We’re here to tell you they’re not. There are significant differences between exchange-traded funds and mutual funds.

Key difference 1: Firstly, ETFs, like any other shares, can be actively bought and sold on exchanges. But the only way to buy a unit of a mutual fund—even though it’s listed on the exchange—is from a fund house. What the heck is a fund house? Another name for a fund house is an Asset Management Company (AMC). AMCs are organizations that invest investors’ pooled money in stocks, mutual funds, securities, etc.

Key difference 2: ETFs tend to favor a market index, such as the S&P 500 index, which is thought to be the best single gauge of large-cap equities in the US. Because ETFs are pegged to the performance of a particular stock index (aka, they mimic the ups and downs of the stock market), they can also be a fantastic way to dabble in passive investing. You can use a passive ETF method and invest in a whole index while getting all the advantages of low costs and transparency that are simply not there in active investing.

Key difference 3: EFTs usually have cheaper rates than mutual funds. When you buy exchange-traded funds, you typically pay lower fees than when you purchase mutual funds. Note: This gap is getting smaller and smaller by the day as mutual fund companies are actively competing with ETFs for investors’ money. In fact, mutual fund companies are slashing their fees to compete with low-cost exchange-traded funds (ETFs).

Is that all? Not quite. 

Here are a few more differences between ETFs and Mutual Funds:

  • Mutual funds also tend to outperform the market. That’s why they’re managed by a fund manager or a team who actively select the investments on your behalf. 
  • Mutual fund shares can only be traded after the financial markets close at 4 p.m. EST. But you’re free to trade EFTs throughout the day since their price fluctuates as if they’re stocks. 
  • Depending on an ETF’s investment plan, you can also use stop, margin and limit orders on it or simply “go short.” What the heck is “selling short”? That’s when you sell shares you don’t own but have borrowed, usually from a brokerage. Since ETFs are treated like stocks on exchanges, they’re allowed to be sold short.
  • Some mutual funds have a minimum investment requirement. But ETF investors can buy a single share (or even less if their brokerage allows fractional trading).  

Wondering what some popular ETFs to invest in are? We’ve got you covered with that too.

Three common types of ETFs 

There are three most common ETF types in the market:

Broad index-based ETFs: These follow popular indexes like the S&P 500 stock index, which we already explained when we told you about the difference between an ETF and a mutual fund. Index ETFs can follow many different indices.

Niche or sector ETFs: This type tracks a narrower part of the market and represents unique market segments, like gold or oil. Alternatively, they focus on a minor part of a larger group of assets (e.g., small companies, foreign companies, or cybersecurity companies). When people buy these ETFs, they usually face more political, currency, and market risks.

Actively managed ETFs: This type is run by a team of investment managers who do research and decide how the ETF’s portfolio should split up.

And that’s it – those are the three main types of ETFs. 

A quick note on ETF expense ratio calculator 

The expense ratio is a fee charged by mutual funds and ETF providers for managing this asset. That’s why the expense ratio of an ETF reveals how much of your investment will be taken in fees each year. 

How do we calculate it? A fund’s expense ratio equals the fund’s operating costs divided by its average assets. So, the actual performance of your investment is the ETF performance minus the annual expense ratio.   

Ready to start your ETF Journey? Here’s how:

Step 1

Open your trading and investing account.

Step 2

Select your ETFs after doing extensive research.

Step 3

Let your ETFs do the work in the long run.

Step 1: Create a brokerage account 

Before you start investing in ETFs, you’ll need a good brokerage account. Most online brokers now provide commission-free stock and ETF trading, so the price isn’t sky-high. The best option is to closely examine the platforms and features of each broker and pick the one that best suits your investing goals. 

If you’re a beginner investor, it’s a good idea to go with a broker like E*Trade (NASDAQ: ETFC), TD Ameritrade (NASDAQ: AMTD), or Schwab (NYSE: SCHW). That said, there are plenty of others to pick from. 

You can also open an account and trade a wide range of ETFs with amana. We give you the possibility to trade thousands of ETFs through our all-in-one app. What’s more, you can enjoy both commission-free and fractional trading. Not to brag, but we’re also an excellent choice for those looking for UAE ETFs or Saudi ETFs.

Step 2: Select your ETFs 

Passive investing in ETFs is often the best choice for those new to trading. Index funds are less expensive than actively managed funds, and most actively managed funds don’t meet their benchmark index over time. 

With that in mind, here’s a list of the best ETFs for those of you only starting to build your portfolios,  based on expected returns, momentum, and expense ratio, among other factors.

You’ll also find a note of what each invests in. 

Schwab U.S. Mid-Cap ETF (NYSEMKT: SCHM) 

Invests in medium-sized US companies.

Schwab International Equity ETF (NYSEMKT: SCHF)  

Invests in more prominent non-U.S. companies.

Vanguard Russell 2000 ETF (NYSEMKT: VTWO)  

Invests in smaller US companies.

Schwab Emerging Markets Equity ETF (NYSEMKT: SCHE)  

Invests in companies from countries with developing economies.

Vanguard Total World Bond Fund (NASDAQ: BNDW)  

Invests in international bonds and US bonds of several durations and maturities. 

Invesco QQQ Trust (NASDAQ: QQQ)  

Invests in the Nasdaq-100 Index, aka tech and other growth-related stocks.  

What are the best ETFs to buy and hold?

You’re probably wondering what would be the best ETFs for long-term growth? It’s hard to say as there are pros and cons for any ETF. But we can tell you that Vanguard and Schwab both provide low-cost stock market access, which is why their ETFs are among the most affordable in the industry. 

Step #3: Let your ETFs do the work 

It’s important to remember that ETFs are often designed to be low-maintenance investments. What does that mean?

It means newer investors have a bad habit of checking their investments frequently and reacting emotionally to significant market movements. In reality, so-called “over-trading” is the primary reason the regular fund investor underperforms in the market over time. 

So, once you’ve invested in some strong ETFs, the best suggestion is just to let them be and do what they’re supposed to do: generate great long-term investment returns. 

Bottom line

ETFs allow you to invest without being as hands-on and are a simple way to get started in the market. 

If you’re unsure how to choose ETFs for your portfolio, open an account with a reputable broker like amana, where you can tap, swipe and trade a wide variety of ETFs. Many such companies recommend low-cost ETF portfolios so you can benefit from the investment vehicle without exploring the numerous options. 

Why invest in EFTs with amana 

At amana, we offer you a wide variety of exchange-traded stocks.  These stocks are traded on an organized exchange, an approved alternative trading venue, or directly with specialists or market makers with an inventory to buy and sell. 

The price of each transaction has to meet specific regulatory requirements, which tend to differ by country. In the US, for example, there’s always a nationally recognized best bid and offer. This is sometimes referred to as NBBO. Because of that, it would be a violation for any broker to execute a trade at a price worse than NBBO, and a broker that executed such a transaction would be guilty of a crime according to US law.  

All amana exchange-traded stocks are executed in a fully compliant way determined by each country’s best execution rules, and we take pride in that.

Ready to start trading with us? Explore hundreds of ETFs on the amana app.

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