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What Are Exchange-Traded Funds, and How Did They Get So Popular?

There are various investment funds, and one of the most popular and widely used ones includes the ETF or exchange-traded fund. ETFs are somewhat like a combination of two other popular assets: mutual funds and stocks. They are like a mutual fund in terms of diversification benefits — but cheaper. On the other hand, they are also like stocks in the way they are traded. Let us know more about them and why brokers and brokerage firms even offer free trading of one of few ETFs.

Learning more about exchange-traded funds

Exchange-traded funds, also popularly known as ETFs, are investment funds that people can trade on exchanges. This is just like how we would trade stocks— they can be bought or sold throughout the trading day.

ETFs, come with different types and levels of risks. So, before engaging in ETFs, research and analyze well. Know the easiest ways to buy or sell them. Know if it is worthwhile. Know all the details — even management costs and commission fees, if there are any.

How does an ETF work?

Let us enumerate the most important people involved in ETFs to understand them further:

  • Fund providers. They are the ones who own the underlying assets. They are also the people responsible for designing a fund that will track the ETF’s performance. Later on, the fund provider can sell fund shares to investors.
  • Shareholders. They are not the owners of the fund’s underlying asset but own a portion of an ETF.
  • Investors. ETF investors can also track stock indices. These investors may receive lump dividend payments or reinvestments because of the stocks that make the indices.

Now that we know that ETFs tracks either the underlying asset’s or the index’s value. And when we say underlying asset or index, we may be pertaining to commodities like copper, gold, silver, or coffee. We may also be referring to a basket of stocks like S$P 500. We can trade ETFs at prices dictated by that market. This price is usually nothing like the asset. The long-term returns that we expect from an ETF may not be the same as the underlying asset because of many factors like costs and expenses.

Here is a bulleted and more straightforward explanation of how ETFs work relative to the people we enumerated earlier:

  • An ETF provider chooses from the pool of assets like stocks, commodities, bonds, currencies, etc. He will make a basket out of those and a unique ticker.
  • Investors may buy shares from that basket. Buying these shares is no different from buying ones from a company.
  • ETFs are now tradable. People can buy and sell them on an exchange, just like how we would trade a regular stock.

Should I trade ETFs?

People say that ETFs are one of the causes of market volatility. ETFs may not grow that fast in an instant, but they surely will in the coming years. ETFs are convenient and affordable. They also offer a wide range of market and investment options.