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ETF allow investors even with a small capital to diversify their portfolio. All you have to have is an account with a broker. Investing in the S&P 500 index fund is an excellent example of index ETF. If an investor were to pick stocks to build the same portfolio independently, it would take a lot of time, knowledge and money. With an ETF, the task is as simple as it gets, as it costs as an ordinary stock, while the funds are managed by professionals.
What is an ETF?
An ETF (Exchange Traded Fund) is a fund that can be traded like a stock on an exchange. It was conceived as a liquid marginal asset, which is placed on the trading platform (just like shares after an IPO). Any ETF is based on the chosen index and fully replicates its structure. The fund can replicate the structure of assets of the indices of the commodities market, stock and bond market, and also precious metals and foreign currencies. As of today, there are over 10,000 different ETFs.
An ETF is an excellent alternative to traditional futures and stocks thanks to risk diversification. Working with an ETF, an investor, in fact, sells or buys a whole basket of certain assets. Compared to other trading instruments, exchange-traded funds have a number of benefits, which makes them popular among traders.
If you are planning to work with exchange-traded funds, you need to understand the specifics of this market. It has two “layers”:
Primary ETF market
Secondary ETF market
Only ‘qualified participants’, which include investment organizations and hedge funds, have access to it. Any participant can launch an ETF and exchange stocks in large packages (from 50,000 and more) in order to earn a profit. In addition, the market players can sell ETFs they purchased earlier.
This is a market for private investors (legal entities and private individuals). Purchase and sale of ETFs is carried out similarly to other instruments. It is as easy to buy a share in the fund as to buy an ordinary stock.
Despite that ETFs can be referred to as an equivalent of classic assets, there are many differences. First of all, exchange-traded funds have a composite structure. You are essentially working with a diversified portfolio of assets, which improves your chances at earning a profit and reduces risks. This financial instrument will be particularly interesting for long-term investors. They do not need to analyze and pick dozens of securities; they can simply invest in exchange-traded funds and earn a profit. Professional investment managers are the ones tasked with building ETFs. Read more in the article: ETFs Versus Mutual Funds: What is the Better Option?
For private investors, the benefits of ETF trading are as follows:
Tax effectiveness;
Order diversify (Limit, Stop Loss, etc.), which Mutual Funds don’t have;
A possibility to trade round the clock (even after the market closes);
• Growth of ETF value does not depend on the desire of the manager, as exchange-traded funds always follow the index
• Wide selection of ETFs – there are over 10,000 of them now
👎 Cons
• ETF owner does not become the owner of a stake in the company
• The structure of exchange-traded funds is not always transparent
• Many ETFs have no dividends
• There are ETFs with increased risks for investments (in particular, field-specific exchange funds)
As you can see, ETFs are a rather interesting investment instrument that opens access to markets of different countries. At that, building a diversified portfolio from different assets requires a rather small amount of investment, which is extremely beneficial for retail investors. However, investors still need to take risks into consideration and invest only in reliable funds with good business reputation.
In order to choose an ETF, you can use the broker’s platform or one of the financial portals. For example, there is an excellent ETF map on the Finviz.com portal. It has the following benefits:
It shows the picture of the ETF market by sectors;
It shows performance of each fund for the last day, week, month, or year;
It provides the names of the best ETFs and the exchange ticker for searching on the broker’s trading platform.
Judging by the data from the portal, the best large ETFs, in terms of profitability for the past year, are as follows (as of 20.08.2023):
ETF
Sector
Profitability
VTI
Index ETFs
31.98%
SPXL
Margin ETF
112.57%
SCZ
International stock markets
28.96%
XLK
US technology segment
33,.79%
IWF
US large-cap index
30.19%
Noteworthy, the year 2023 is a very successful year for the stock market, while ETFs only reflect high profitability. However, investors need to keep in mind that profitability in the past is not a guarantee of the same result in the future. The market can both grow and fall.
There are several ways to invest in an exchange-traded fund and start earning money from it: using the managing investment company, major banks, independently via a broker at an exchange. Many traders believe the last option to be the easiest and most profitable one. Some top brokers offer a choice of more than 1,000-2,000 different ETFs.
In addition, there are other advantages of buying ETFs via a broker. Firstly, you don’t have to be a qualified investor (as is the case with NYSE Arca). Secondly, many financial agents offer a demo account, where you can test trading ETFs without risks. Entry threshold of some brokers is $100-300, which allows traders to start trading ETFs with low risks for their budgets.
In order to buy an ETF, follow this simple algorithm:
Choose a brokerage company and register on its website;
Make a deposit for the suitable amount of money;
Select an ETF;
Open an order via the trading platform or by phone in order to buy the ETF.
Building an ETF basket does not require some specialized financial knowledge. You simply need to apply basic principles of investment and monitor macroeconomic news in order to understand the prospects of certain sectors. For example, some users will be interested in the US IT sector (MSCI USA IT ETF), and others – in the Chinese economy (MSCI China ETF). Also, many brokerage companies offer the assistance of analysts, who are ready to provide advice on the issues the trader is interested in.
Legendary investor Warren Buffet believes that the S&P 500 index fund is the best option for novice investors. S&P 500 grows 10% per year on average, which is much better than deposits at the banks. At the same time, the investors don’t need to have a lot of money in order to start investing (just a few hundred dollars); this investment is highly diversified and the management fees are currently very low – less than 1% in the majority of funds.
This broker is the champion of ETF availability as it provides access to trading on 28 exchanges in 14 countries. The platform offers hundreds of ETFs on indices of the U.S., Canada, Germany, developing markets and different sectors of the U.S. and global economy. The trading commissions here are very low, from $0 per stock.
FAQs
What is the minimum threshold for buying an ETF?
You can start with a minimum amount – the majority of funds are traded at a price lower than $500.
What are the risks of ETF trading?
They are typical market risks – the index, the structure of which an ETF replicates, can both grow and fall. Therefore, investors need to choose ETFs carefully.
How much can I earn from ETFs?
There is no specific amount. The average historical profitability of the S&P 500 index is 10%; however it is not guaranteed, there was 20-30% growth some years and decreases in other years.
Why are ETFs so popular?
This is the most affordable method of investment for the beginners. However, professionals also buy ETFs, as they rid them of the necessity to pick stocks in the right proportion independently. It is way easier to buy an index with just one click.
Ivan is a financial expert and analyst specializing in Forex, crypto, and stock trading. He prefers conservative trading strategies with low and medium risks, as well as medium-term and long-term investments. He has been working with financial markets for 8 years. Ivan prepares text materials for novice traders. He specializes in reviews and assessment of brokers, analyzing their reliability, trading conditions, and features.
Olga Shendetskaya has been a part of the Traders Union team as an author, editor and proofreader since 2017. Since 2020, Shendetskaya has been the assistant chief editor of the website of Traders Union, an international association of traders. She has over 10 years of experience of working with economic and financial texts. In the period of 2017-2020, Olga has worked as a journalist and editor of laftNews news agency, economic and financial news sections. At the moment, Olga is a part of the team of top industry experts involved in creation of educational articles in finance and investment, overseeing their writing and publication on the Traders Union website.
Olga has extensive experience in writing and editing articles about the specifics of working in the Forex market, cryptocurrency market, stock exchanges and also in the segment of financial investment in general. This level of expertise allows Olga to create unique and comprehensive articles, describing complex investment mechanisms in a simple and accessible way for traders of any level.
Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO). Mirjan is a cryptocurrency and stock trader. This deep understanding of the finance sector allows her to create informative and engaging content that helps readers easily navigate the complexities of the crypto world.
