What is an ETF?

Exchange-Traded Funds (ETFs) are a popular alternative for investors who wish to buy a basket of assets without having to purchase each of the stocks individually. ETFs combine all the costs of purchasing multiple stocks into the initial acquisition of the ETF and an ongoing expense ratio paid for the duration you hold the ETF.

The main benefit of an ETF is the ability to diversify your portfolio with a relatively small investment.

ETFs function similarly to stocks on the market. Like regular stocks, they are listed on major exchanges such as the London Stock Exchange, New York Stock Exchange, Shanghai Stock Exchange, and other major European exchanges. Their prices fluctuate throughout the trading day, unlike mutual funds, which are only traded at the end of the day.

Another key difference from mutual funds is that ETFs can be used in options trading, including both calls and puts, allowing experienced investors to apply strategic trading approaches.

A central feature of an ETF is its Net Asset Value (NAV). This is the value of all the assets held by the ETF (stocks, cash, etc.), minus any liabilities, divided by the number of outstanding shares. NAV is calculated daily and reflects changes in the value of the ETF’s holdings.

Authorized Participants (APs) are special institutional investors who help keep the ETF’s market price in line with its NAV. When the ETF trades at a premium (above NAV), APs create new shares by delivering underlying assets to the fund. This increases supply and helps reduce the price. Conversely, when the ETF trades at a discount (below NAV), APs redeem shares, reducing supply and pushing the price back up toward the NAV.

It's essential to understand what you're investing in when considering an ETF, just like with any other stock. Being informed is the best way to make smart investment decisions. Here are several key factors to consider:

Understand the ETF's Objective and Holdings

• What is the ETF investing in? Is it tracking a sector, bond, or index?
• Does it align with your goals—diversification, income, or growth?
• Always check the holdings before investing.

Expense Ratio (Costs)

• This is the annual fee charged by the ETF provider.
• Lower expense ratios mean lower costs affecting your returns. Typical ranges: 0.03% to 1%.
• Even small fee differences add up over time.

Liquidity and Trading Volume

• ETFs with higher daily volumes are easier to buy or sell without large price swings.
• Higher liquidity usually means tighter bid-ask spreads (lower transaction costs).

Tracking Error

• Tracking error shows how closely the ETF mirrors its benchmark.
• A smaller tracking error is better.

Diversification

• Look at how many different assets the ETF holds.
• Diversification helps spread risk across various investments.

Dividend Yield (If Applicable)

• If you're investing for income, check the dividend yield and payment schedule.
• Some ETFs specialize in dividend-paying assets.

Issuer Reputation and Fund Size

• Stick with reputable ETF providers like Vanguard or BlackRock (iShares).
• Smaller funds (low AUM) may be at risk of closure, which can be costly.

When investing in ETFs, always make sure the fund matches your personal risk tolerance. Some ETFs, like those focused on specific sectors, can be more volatile than broad-market ETFs.

Don’t rely solely on past performance when making a decision. Instead, understand the ETF’s strategy and how it fits your investment objectives.

Lastly, review your investments periodically. Your financial goals and market conditions may change over time, so it’s important to ensure your ETF holdings continue to serve your needs.