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What Is An ETF (Exchange Traded Fund)?

Updated: Apr 22, 2021

In this article we will be discussing everything "Exchange Traded Funds" or ETF's for short, we will be looking at a number of different themes such as...

  • What is an ETF?

  • Why are ETF's so popular?

  • The Advantages and Disadvantages of ETF's

  • What to look for in a successful ETF

  • How are ETF's regulated?

lets get stuck in!

What does “ETF” actually mean?

An exchange traded fund (ETF) is a type of security that involves investing in a pre-selected collection of stocks that often tracks an underlying index, such as the S&P 500 or the UK100.

They can be used to invest in any number of industry sectors or use various strategies.

ETFs are in many ways similar to mutual funds; however, they are listed on exchanges such a s the New York Stock exchange (NYSE) and ETF shares trade throughout the day just like ordinary stock.

A well-known example is the SPDR S&P 500 ETF (SPY), which tracks the S&P 500 Index. ETFs can contain many types of investments, including stocks, commodities, bonds, or a mixture of investment types.

Just like a stock you can buy and sell an ETF within normal market hours on any exchange that offers them. they trade just like a currency or share in this way as you can send orders through either your broker or however you access the markets.

ETF’s are one of the most popular assets to trade, many have dedicated asset managers and whole teams of analysts and administrative staff, all keeping tabs on the stocks inside the ETF, making decisions every day, assessing their performance and their outlook for the next 5-10 years.

They also look for potential companies to add into the ETF or “fund” companies are either headhunted or they apply to join the fund.

Why should I invest in an ETF?

An ETF is called an exchange traded fund since it's traded on an exchange just like stocks. The price of an ETF’s shares will change throughout the trading day as the shares are bought and sold on the market.

Exchange-traded funds (ETFs) have a number of features that are ideal for smaller investors without the amounts of capital to invest seen by the hedge-funds or investment bankers. ETF’s make it possible to build a diversified portfolio. The importance of diversifying your portfolio to reduce risk is vital in any investment strategy.

The major ETF’s are effectively a pre-built portfolio done for you by asset managers with teams of analysts and traders, most companies that run multiple ETF’s such as Vanguard or iShares will have profiles for each of their different Funds with reports, data, accounts and much more info for every single ETF that they run.

This means that before you even invest in one you can do your own analysis very easily and fit one that suits you risk.

ETF’s are normally very liquid assets – meaning they are very popular with traders, as multiple market makers or brokers compete to offer the tightest possible spreads to draw in client, much different to currency in this way, along with the diversification that you can have with any specific ETF this is a good mix of cheap entry and lower risk.

Why should I diversify my investments?

This is a core principle in any type of investing or risk management, the reason that you need to diversify your assets is to spread your risk as to protect your portfolio and, more importantly, your money if something happens to one of your investments.

To explain it better I like to think of a polar bear in ice…

Polar bears are very heavy animals – the average male weighs around 450kg!!

(yes, I did the maths)

These majestic creatures often walk over massive frozen oceans and bodies of water, and even though this ice is fairly thick, 450kg is still enough to break through… so why don’t polar bears fall through the ice?

Polar Bears are a perfect example for investors in spreading your risk, their hugely wide paws allow the to walk over even thin sheets of ice with no worries, this is due to the fact that their weight is spread over a wide surface area, meaning that in all they are less likely to fall in to the freezing water as there is no concentrated pressure on a specific part of the ice.

Relating this back to investing the reason that you should diversify is so your spread your investments over different sectors/industries, that means if for example the physical retail industry where to have a bad year, then your investments in the online retail sector would be able to contrast this and help what we call “hedge” your losses.

There is always risk with any type of investing, especially when dealing with the financial markets, however, diversification is one technique that ETF managers use to reduce this eve of risk to as low as possible.

Look out for another blog explaining this in more detail soon…

What do ETF's look like?

With ETF’s, one single trade can allow you to access any asset class or are of the world, to illustrate this take a look at the asset classes that investment company Lyxor provide…

Everything from European Banks to Taiwanese companies the possibilities are endless, and there are so many different investment firms out there that run ETF’s its easy to find one that you like.

This only used to be possible for big institutional but ETF’s make it accessible to anyone!

How are ETF’s regulated?

This varies depending on where you are around the world, in Europe they are regulated by the UCITS organization, ETF’s must meet certain standards that are set if they want to be available on exchanges, they must meet standards on, Diversification, transparency and liquidity.

This is very similar wherever you are trading and ensures traders are kept safe and the ETF’s aren’t doing anything untoward like mis-representing data or accepting companies shares into the ETF that are under investigation or could be seen as defrauding investors.

The Pro's of ETF's: