What is an ETF? 5 Reasons Why They Beat Mutual Funds

What is an ETF? 5 Reasons Why They Beat Mutual Funds


Robert Watkin

05 October, 2022

Category: Personal Finance Basics

ETF (Exchange Traded Fund) is a type of investment fund that tracks an index or group of securities. The main advantage of investing in ETFs over mutual funds is their low cost. This means investors get access to diversified portfolios at lower costs.

There are several advantages of using ETFs instead of mutual funds. In today's post I will be discussing the benefits of investing in ETFs and how they can help you achieve your financial goals.


What Is an Exchange-Traded Fund (ETF)?

An exchange traded fund is a collection of securities that track an index—such as the S&P 500 Index, Dow Jones Industrial Average, Nasdaq Composite, Russell 2000, or the Euro STOXX 50—and trade like individual stocks. They are popular because they offer diversification benefits and lower fees than buying and holding individual stocks.

ETFs offer a great way for investors to gain exposure to different sectors of the market without having to buy each stock individually. For example, if you want to invest in technology companies but don’t have time to research all the tech stocks available on the market, then you can use an ETF to gain exposure to this sector.

Most ETFs can be purchased through typical stock exchanges where you would normally purchase any other stocks or shares. Different ETF's may be purchased through different stock exchanges and some you may have to purchase direct through the ETF providers websites.

ETFs can also be purchased during the trading day like any other financial asset or the underlying assets of the ETF.


Why are ETFs popular?

ETFs are an easy way for investors to gain exposure to multiple assets without having to buy individual stocks or bonds. An exchange traded fund is just like owning shares of stock in companies such as Apple Inc., Exxon Mobil Corp. or Boeing Co.

An investor could purchase an entire sector of the market — say, technology — by investing in one ETF. Or an investor might want to focus on a specific industry, such as energy, health care or consumer products. By purchasing a broad basket of ETFs, an investor can achieve those goals.

The main difference between an ETF and a traditional mutual fund is that you don't actually hold the underlying securities yourself. Instead, you trade shares of the ETF on financial markets. This allows you to buy and sell shares quickly and efficiently.

ETFs are often less expensive than buying individual stocks because there is no management fee. You pay a small amount per share to buy into the fund, but you'll never have to worry about paying a sales load or redemption fees. In addition, many ETFs charge low annual expenses compared to mutual funds.

ETFs also provide another option for day traders with the wide range of ETF options available. There are a wide variety of investment strategies available which can be applicable depending on the basket of securities within the ETF.


What are the pros of ETFs?

ETFs are easy to understand, invest in, and trade. They offer diversified portfolios that track indexes like the S&P 500 Index, Dow Jones Industrial Average, Nasdaq Composite, Russell 2000, or even foreign markets. And because they're traded on exchanges, you don't have to worry about commissions or taxes.

But there are some downsides to investing in ETFs. For one thing, they tend to cost more than mutual funds. But it's worth paying up front for the benefits of low fees and broad diversification.


Types of ETFs

There are many different types of Exchange Traded Funds (ETFs). They differ based on what assets they hold, how they trade, and whether they are focused on one type of security or multiple ones. Here are some of the most common types of ETFs:

1. Diversified ETFs - This category includes funds that invest in stocks, bonds, commodities, currencies, real estate, and other securities.

2. Commodity ETFs - These funds focus on investing in specific commodities such as gold, oil, copper, wheat, etc hence commodity ETF

3. Equity ETFs - These funds seek to match the performance of a particular index like the S&P 500 Index.

4. Bond ETFs - These funds invest in government debt instruments like Treasury Bonds, corporate bonds, municipal bonds, mortgage backed securities, and others.

5. Real Estate Investment Trusts (REITs) - REITs are companies that purchase properties like office buildings, shopping centers, hotels, apartment complexes, and other commercial real estate.

6. International ETFs - These funds allow investors to buy shares of foreign companies and countries.


Passive and Active ETFs

ETFs are one of the most popular ways to invest in stocks because they allow you to buy shares of companies without having to research each stock individually. However, there are several types of ETFs, such as passive and active ones. These terms refer to how the fund invests in securities.

A passive ETF simply tracks an index like the S&P 500 Index, whereas an active ETF seeks to outperform it. You might think that investing in an actively managed ETF would cost more than investing in a passive ETF, but that isn't always true. Fees can vary widely depending on what type of ETF you're looking at. For example, some actively managed ETFs charge lower fees than others.

The chart above compares the fee structure of three different types of ETFs: a passive bond ETF, an actively managed currency ETF, and an actively managed equity ETF. All three ETFs offer investors the same total return potential. However, the actively managed ETF charges slightly less in fees than the other two. This is important because it demonstrates that even though actively managed ETFs often promise better returns, they aren't necessarily more expensive.


5 Reasons Why They Beat Mutual Funds

Investing in ETFs has become increasingly popular over the past few years. In fact, according to Morningstar, ETFs accounted for $1.8 trillion in assets under management in 2017. That's nearly double their value from just five years ago.

So why do so many people choose to invest in ETFs instead of traditional mutual funds? There are several reasons why ETFs beat out mutual funds when it comes to investment options. Let's take a look at them below.

1. Lower Costs

Mutual funds have higher operating costs than ETFs. The reason for this is simple: mutual funds must pay sales commissions to brokers who sell them, while ETFs don't need to pay these fees. Instead, ETFs use low-cost trading platforms operated by exchanges.

2. More Diversification

Mutual funds tend to be very concentrated in certain sectors or industries. As a result, if a company within those sectors goes bankrupt, your entire portfolio could suffer. On the other hand, diversified ETF portfolios can withstand losses in individual sectors.

3. Easy Access

You can access ETFs through online brokerage accounts, which means you can trade them whenever you want. With mutual funds, however, you typically have to wait until the end of the day to make trades.

4. No Management Fees

While mutual funds may require ongoing management fees, ETFs don't. This makes them much cheaper to run than mutual funds. There are still some ETFs which have associated fees however they will usually be a lot lower then mutual fund fees

5. Liquidity

Most mutual funds require shareholders to hold their investments for long periods of time before selling them. This makes it difficult to get rid of unwanted holdings. By contrast, ETFs are much easier to liquidate.



ETF's are a great way to diversify your portfolio. There are many different types of ETF's available today. The type of ETF you choose depends on what kind of return you want to achieve. Whether you're looking for income, growth, value, or exposure to specific industries, there's an ETF for that.

I am not a financial advisor and anything I say in my blog is not to be taken as financial advise. For any financial advise please contact a financial professional. My blog is based on my own opinions, research and understanding of the financial markets.

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What to Look for in an ETF

After creating a brokerage account, investors will need to fund that account before investing in ETFs. The exact ways to fund your brokerage account will be depend on the broker. After funding your account, you can search for ETFs and make buys and sells in the same way that you would shares of stocks. One of the best ways to narrow your ETF options is to utilize an ETF screening tool. Many brokers offer these tools as a way to sort through the thousands of ETF offerings. You can typically search for ETFs according to some of the following criteria:

Source: investopedia.com

Do ETFs pay dividends?

Yes, as long as the underlying stocks held within the ETF pay dividends. These companies' dividends are collected by the ETF issuer and distributed to investors, typically quarterly, based on the number of shares the investor owns in the ETF. However, if none of the underlying companies in the ETF offer dividends, the ETF won't pay dividends, either. Some ETFs are constructed specifically to maximize dividend income, known aptly as dividend ETFs.

Source: nerdwallet.com

Why are ETFs important?

ETFs are hugely popular. In 2020, , almost six times more than a decade ago. And thanks to an explosion of interest in low-fee index investing, ETFs have spawned an entirely new category of financial companies: so-called roboadvisors like Betterment and Wealthfront that invest in ETFs almost exclusively.. $7.74 trillion in assets worldwide were invested in ETFs

Source: coinbase.com


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