Diversify your portfolio with one purchase and enjoy the ease of trading stock.
If you are looking to experience diversification without having to make multiple investments, an exchange-traded fund might be for you. With many advantages, ranging from tax efficiency, diversification, and the ease of trading, many investors are finding that ETFs are a great tool to both earn money as well as hedge their portfolio.
What is an ETF?
An exchange-traded fund, or ETF, is a security that tracks a commodity, bonds, basket of assets, or index, that are traded like a stock on the stock exchange. With a high daily liquidity and lower fees than mutual fund shares, they experience daily price changes as they are bought and sold. ETFs are a very popular alternative for investors.
The funds that are considered ETFs own an underlying asset, like stocks, gold bars, foreign currency, etc. The ownership of the assets is separated into shares. Shareholders are entitled to a portion of the profits. As stocks, shares are easily bought and sold as they are traded on the public stock exchange.
Advantages of ETFs
There are many advantages to investing in ETFs. For one, investors gain the diversification of an index fund. ETFs track a wide range of stocks that are trying to mimic the returns of a country or group of countries, similar to mutual funds. Many different funds exist, from international ETFs, regional ETFs and simply country-specific ETFs. There are also market niches. There are also asset classes available.
The exchange-traded funds make it easy for investors to build their portfolio by meeting asset allocation needs.
ETFs have lower fees than mutual funds, however, and trade like equity. Exchange-traded funds trade like a stock. Investors have the ability to short sell, buy on margin, and those not looking to invest a lot of money can purchase as little as one share. The price of the funds are updated throughout the day, unlike a mutual fund, that is priced at the end of the day at net asset value. Also, like a stock, investors can manage their risk by trading futures and options.
ETFs can also some attractive tax benefits. Most of the tax on capital gains is paid on sale and is completely dependent on the investor. Investors trading large volumes of ETFs have the ability to redeem them for shares of stocks that the ETFs track, minimizing tax implications. For the investor because they can defer most tax until the investment is sold.
Types of ETFs
Commodity ETFs focus on a certain area of a market. This can include purchases such as gold and energy. With an ETF, however, you don’t actually always buy the commodity. The commodity ETF is derivative contractions that emulate the price of the commodity.
It’s good to note that commodities have had little correlation with equities. Commodity ETFs allow investors to not only invest in a commodity but also diversify within the asset class. This can be said about all ETF, whether it be real estate, cash, or bonds.
Fixed income funds, such as bonds and bond ETF, are popular amongst most financial professionals. With these ETFs, an investor can reduce a portfolio’s volatility and provide additional income at the same time.
Investors can buy and sell foreign currency ETFs that allow investors to gain exposure to foreign currency minus the complex transactions. In many cases, a currency ETF tracks a basket of currencies that give investors access to more than one currency at a time.
There are many reasons one would choose to invest in a foreign currency, mostly protecting from risk. For one, diversification plays a key role in any healthy portfolio. By buying other currencies, you can hedge yourself against losing out from another investment or also gain from economic strength of another nation.
Real Estate Funds
Real estate investment trusts are quite attractive in terms of yield, even with a volatile market compared to bonds. Individuals can choose to invest in a certain kind of real estate or a fund that is broader in nature. Also, the fund must pay out 90% of their taxable income to the shareholders.
With an industry ETF, the fund is tracking a sector index that represents a specific industry. Investors are exposed to wide range of markets without having to invest in multiple companies. The ETFs allow you to invest in multiple companies with just one purchase.
While ETFs grow in popularity, so do the number of funds available. Two that are becoming more popular are inverse funds and leveraged funds. Inverse funds profit when a certain index is not performing well. Leverage funds can double or triple returns of a certain index by leveraging. Volatility is high with these investments and are unreliable long-term investments but can often result in a quick profit.
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