Exchange traded funds have been around for over two decades, but many investors are just beginning to get acquainted with the investment vehicle. So, what are ETFs?
The majority of ETFs passively follow the performance of a benchmark index, which is comprised of a group of securities – something like a mutual fund. However, unlike mutual funds, ETFs are traded on a public exchange, like common stocks. [Five Differences Between Index Funds and ETFs]
Due to the way ETFs trade, the investment vehicle appeals to more active traders and investors, according to Kapitall. Instead of picking out stocks, investors who want to play a broad index can pick out ETFs. Additionally, ETFs can be used for speculative bets through short trades. [What is an ETF? — Part 1: The Basics]
Since ETFs are essentially made up of tens, hundreds or thousands of individual securities from a benchmark index, the ETF will often closely track the underlying index. However, no two ETFs are created equal, and different ETFs that cover the same market space may show slight divergences due to a number a factors, including component weightings and fees, among others.
ETFs also allow investors to ride market trends, providing access to a diverse range of broad assets categories and sectors. Due to their broad coverage, ETFs also provide instant diversification to a market area as opposed to investing in a couple of single stock picks.
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.
Full disclosure: Tom Lydon’s clients own SPY.
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