Have you ever wished you could just buy a little piece of a lot of different stocks so that you could be diversified without having to pay a separate commission fee for every single stock? Well, you can! Its called an “Exchange Traded Fund” or ETF for short and it may be the perfect way to diversify your portfolio or gain exposure to a certain sector of the market. Today we are going to cover the basics of an ETF so you can decide if it fits well with your investing strategy.

What Exactly Is An ETF?

An ETF is an investment strategy where money is pooled together from several investors and invested by a fund manager into a variety of stocks, bonds, and other equities. This allows the investor to potentially be diversified in several different equities by buying a single share of an ETF. Depending on how the ETF is managed by the fund manager will determine the fees associated with investing in an ETF. ETFs are also traded throughout the course of the day so it acts similar to a normal stock. The types of securities that are held in an ETF all depends on the particular ETF you buy. The performance of the ETF you buy will depend on the performance of the underlying securities inside that ETF.

Picking the perfect ETF

Deciding what ETF to invest in depends on what type of securities you want exposure to and your individual risk tolerance. Let’s break down the two most common ETFs on the market.

Index Fund

An Index fund seeks to match the performance of a larger index such as the S&P 500 or the Dow Jones 30. An Index fund will be comprised of all or most of the securities found in one of these larger indexes so your gain or loss should closely match that of the particular index which your ETF follows. Typically an index fund will provide the investor with the greatest amount of diversification. Index funds typically have lower fees associated with them because they require very little management.

Sector ETF

A sector ETF is geared to match the performance of a particular sector of the market such as technology or financial securities. Let’s say that you are bullish on the technology sector but you don’t want to put all your eggs in a single basket. By purchasing an ETF that is focused on the technology sector you can gain exposure to multiple equities in this sector without the risk of losing large sums of money do to a single stock underperforming. Keep in mind that these types actively managed ETFs tend to have higher fees than index funds.

What To Pay Attention To

The Prospectus

The prospectus for an ETF is a document created by the manager of the fund that lays out all the details about that ETF. These documents can be long and sometimes be confusing to read but none the less are important. The prospectus will tell you about the person managing the fund, the fees associated, the goal of the fund, and of course all the different underlying securities that make up the fund.

Fees Associated with the fund

Whether the fund offers a fee of 0.5% or a fee of 1.5% may not seem like it makes a big difference but fees add up over time and can really begin to chip away at the potential gains. When comparing different ETFs make sure that you take the management fees into consideration.

Stay away from leveraged and inverse ETFs

Leveraged ETFs are intended to amplify the returns of the underlying securities the ETF is composed of. The fees associated with these ETFs tend to be high and your potential downside is much more than your potential upside. Do not buy.

Inverse ETFs are intended to perform the opposite of the underlying securities that make up the ETF. Once again, fees are high and these types of ETFs often do not match in terms of gain, the amount the underlying securities go down. These ETFs are very speculative and highly risky. Do not buy.

Remember today we just covered the basics, be sure to do more research before investing in an ETF. They may just be the perfect addition to your portfolio! Let me know what you think by leaving a comment below or click on the “contact” tab at the top of the page to email me any questions and as always thanks for reading and have a great day!