Exchange-traded funds (ETFs) were launched in 1993 with the first U.S. fund, Standard & Poor's Depositary Receipts, better known as spiders (SPDRs). This first ETF tracked the S&P 500 and its popularity with investors led to the introduction of ETFs based on other indexes, such as the Dow Jones Industrial Average and the Nasdaq 100.
Key Takeaways
- Exchange-traded funds (ETFs) were launched in 1993.
- Investing in ETFs can be a low-cost strategy to build an optimal portfolio.
- Several tools help investors find the right ETFs based on cost, asset class, or index.
Investing in ETFs
As of Nov. 2023, over 3,000 ETFs were listed on U.S. exchanges with combined assets exceeding $7.6 trillion. ETFs range from traditional index ETFs based on U.S. and international equity indexes and subindexes, and others that track benchmark indices in bonds, commodities, and futures.
There are ETFs based on investing style and those that focus on market capitalization. Leveraged ETFs provide returns or losses based on the underlying index's movements, as well as inverse ETFs that rise when the market falls and vice-versa.
Investors can narrow their choices using an asset screener typically available on brokerage trading platforms for free or through subscription-based services.
ETF Examples
Funds that track the S&P 500 index include SPDR (SPY), Vanguard S&P 500 ETF, or iShares S&P 500 ETF. Some ETF issuers have developed products with a specific focus. The Range Cancer Therapeutics ETF (CNCR) tracks the Range Cancer Therapeutics Index and invests in stocks that focus on the research and development of drugs and technology to fightcancer using immunotherapy.
ETFs based on new investment trends include the Robotics & Artificial Intelligence ETF (BOTZ) or the Drone Economy Strategy ETF (IFLY). The Obesity ETF invests in companies developing ways to fight obesity and related diseases.
In Jan. 2024, the Securities and Exchange Commission (SEC) approved eleven new spot bitcoin ETFs listed on the NYSE Arca, Cboe BZX, and Nasdaq exchanges.
How to Choose an ETF
Given the number of ETF choices that investors have, it's important to consider the following factors:
- Level of Assets: An ETF should have a minimum level of assets, with a common threshold being at least $10 million. An ETF with assets below this threshold is likely to have a limited degree of investor interest, which translates into poor liquidity and wide spreads.
- Trading Activity: Trading volume is an excellent indicator of liquidity, regardless of the asset class. Generally speaking, the higher the trading volume for an ETF, the more liquid it is likely to be and the tighter the bid-ask spread.
- Underlying Index or Asset: Consider the underlying index or asset class on which the ETF is based. From the point of view of diversification, it may be preferable to invest in an ETF that is based on a broad, widely followed index.
- Tracking Error: While most ETFs track their underlying indexes closely, some do not track them as closely as they should. An ETF with minimal tracking error is preferable to one with a greater degree of error.
- Market Position: The first ETF issuer for a particular sector often garners the lion's share of assets before others jump in. It is prudent to avoid ETFs that are imitations of an original idea.
When Do ETF Investors Pay Taxes?
When the ETF shares are sold and if the ETF was held in a taxable account, the investor will owe taxes on any capital gains.
What Is a Bid-Ask Spread?
A bid-ask spread is the difference between the highest price that a buyer is willing to pay for an asset and the lowest price that a seller is willing to accept.
What Happens During ETF Liquidation?
The ETF issuer will notify investors when the ETF will stop trading. The investor has to decide on the best course of action to protect the investment and determine whether to sell the ETF shares before the "stop trading" date or hold on to the ETF shares until liquidation.
The Bottom Line
When selecting an ETF, investors should consider factors such as its level of assets, trading volume, and underlying index. In the event that an ETF is to be liquidated, an investor has to decide whether to sell the ETF shares before it stops trading or wait until the liquidation process is completed, with due consideration given to the tax aspects of the ETF sale.
The comments, opinions, and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or adopt any investment strategy. Though we believe the information provided herein is reliable, we do not warrant its accuracy or completeness. The views and strategies described in our content may not be suitable for all investors. Because market and economic conditions are subject to rapid change, all comments, opinions, and analyses contained within our content are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment, or strategy.
FAQs
Before purchasing an ETF there are five factors to take into account 1) performance of the ETF 2) the underlying index of the ETF 3) the ETF's structure 4) when and how to trade the ETF and 5) the total cost of the ETF.
How to buy ETF for beginners? ›
How to buy an ETF
- Open a brokerage account. You'll need a brokerage account to buy and sell securities like ETFs. ...
- Find and compare ETFs with screening tools. Now that you have your brokerage account, it's time to decide what ETFs to buy. ...
- Place the trade. ...
- Sit back and relax.
The two ways to see how closely an ETF matches the index performance are 'tracking error' and 'tracking difference'. Tracking difference addresses how closely the ETF tracks the index returns, while tracking error reflects how consistent over time the tracking quality is.
Which type of ETF is best? ›
List of 15 Best ETFs in India
- Nippon India ETF Nifty 50 BeES. ₹ 241.63.
- Nippon India ETF PSU Bank BeES. ₹ 76.03.
- BHARAT 22 ETF. ₹ 96.10.
- Mirae Asset NYSE FANG+ ETF. ₹ 84.5.
- UTI S&P BSE Sensex ETF. ₹ 781.
- Nippon India ETF Gold BeES. ₹ 55.5.
- Nippon India Etf Nifty Bank Bees. ₹ 471.9.
- HDFC Nifty50 Value 20 ETF. ₹ 123.2.
The low investment threshold for most ETFs makes it easy for a beginner to implement a basic asset allocation strategy that matches their investment time horizon and risk tolerance. For example, young investors might be 100% invested in equity ETFs when they are in their 20s.
How many ETFs should I own as a beginner? ›
Experts agree that for most personal investors, a portfolio comprising 5 to 10 ETFs is perfect in terms of diversification.
How much should a beginner invest in ETFs? ›
Exchange-traded funds are similar to mutual funds in that they hold a collection of stocks and bonds in a single fund. Unlike mutual funds, they are bought and sold on stock exchanges, can be traded anytime the exchange is open, and you can start your ETF investing even if all you have to invest is $50.
How many ETFs should I own? ›
The majority of individual investors should, however, seek to hold 5 to 10 ETFs that are diverse in terms of asset classes, regions, and other factors. Investors can diversify their investment portfolio across several industries and asset classes while maintaining simplicity by buying 5 to 10 ETFs.
How much of your money should be in ETFs? ›
You expose your portfolio to much higher risk with sector ETFs, so you should use them sparingly, but investing 5% to 10% of your total portfolio assets may be appropriate. If you want to be highly conservative, don't use these at all.
Should I put my money in ETFs? ›
ETFs can be a great investment for long-term investors and those with shorter-term time horizons. They can be especially valuable to beginning investors. That's because they won't require the time, effort, and experience needed to research individual stocks.
Top U.S. market-cap index ETFs
| Fund (ticker) | YTD performance | Expense ratio |
|---|
| Vanguard S&P 500 ETF (VOO) | 7.7 percent | 0.03 percent |
| SPDR S&P 500 ETF Trust (SPY) | 7.6 percent | 0.095 percent |
| iShares Core S&P 500 ETF (IVV) | 7.7 percent | 0.03 percent |
| Invesco QQQ Trust (QQQ) | 5.8 percent | 0.20 percent |
Both Fidelity and Vanguard have a wide variety of low-cost mutual funds and ETFs. If you're simply looking at the options offered by each firm, Fidelity has more options available.
What are the top 5 ETFs to buy? ›
7 Best ETFs to Buy Now
| ETF | Expense Ratio | Year-to-date Performance |
|---|
| iShares Semiconductor ETF (SOXX) | 0.35% | 14.9% |
| Simplify Interest Rate Hedge ETF (PFIX) | 0.50% | 22.9% |
| WisdomTree Japan Hedged Equity Fund (DXJ) | 0.48% | 23.8% |
| Invesco S&P 500 Momentum ETF (SPMO) | 0.13% | 20.9% |
3 more rowsMay 7, 2024
The single biggest risk in ETFs is market risk. Like a mutual fund or a closed-end fund, ETFs are only an investment vehicle—a wrapper for their underlying investment. So if you buy an S&P 500 ETF and the S&P 500 goes down 50%, nothing about how cheap, tax efficient, or transparent an ETF is will help you.
Is there a downside to investing in ETFs? ›
For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.
What are the best 3 ETF portfolios? ›
3 Top ETFs for a Diversified Stock Portfolio
- SPDR S&P 500 ETF Trust. The SPDR S&P 500 ETF Trust (SPY -0.06%) mirrors the S&P 500 Index, encompassing 500 of the largest U.S. corporations. ...
- Invesco QQQ Trust. ...
- iShares Russell 2000 ETF.
There are no restrictions on how often you can buy and sell stocks or ETFs. You can invest as little as $1 with fractional shares, there is no minimum investment and you can execute trades throughout the day, rather than waiting for the NAV to be calculated at the end of the trading day.
What do you actually own when you buy an ETF? ›
There is no transfer of ownership because investors buy a share of the fund, which owns the shares of the underlying companies. Unlike mutual funds, ETF share prices are determined throughout the day. A mutual fund trades only once a day after market close.
How does ETF work for dummies? ›
A cross between an index fund and a stock, they're transparent, easy to trade, and tax-efficient. They're also enticing because they consist of a bundle of assets (such as an index, sector, or commodity), so diversifying your portfolio is easy. You might have even seen them offered in your 401(k) or 529 college plan.
Do you pay taxes on ETFs if you don't sell? ›
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
