What is an ETF?

By moneyredpill | MoneyRedPill | 18 Apr 2020


An Exchange-Traded Fund (ETF) is a type of security that aggregates a collection of securities, such as stocks, that tracks the price of a market index, industry sector, commodity, foreign currency, Cryptocurrency, or widely-used market unit of measure. These are not limited to domestic only, as there are plenty of international options, regardless of citizenship. Some common examples of ETF’s are SPY (S&P 500), GLD (Gold), SH (Short S&P 500), TVIX (Volatility Index), and UCO (Crude Oil with 2x Leverage). Some ETF’s are suitable for medium- to long-term investment timelines, such as SPY. However, a large percentage are intended for short-term, active management, such as Inverse ETF’s. On the extreme end, leveraged ETF’s are intended solely for intraday use only (trading), and suffer from price decay overnight and over time. Buying shares of ETF’s does provide an investor exposure to a rough price tracking of the underlying asset, however it does not provide the investor actual ownership of the underlying asset.

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For example, if John takes a $10,000 position in UCO (Long Oil with 2x Leverage), he gains exposure to oil prices in the current oil futures contract, and any price movements, up or down, are amplified by 2x, as per the nature of the ETF. However, when John purchases these shares in UCO, he is not delivered $10,000 worth of oil to his home. So why invest in ETF’s? For retail investors and traders, ETF’s are widely available and more easily accessible than other traditional investment assets used by multinational banks, hedge funds, mutual funds, governments, university endowments, and high-net worth individuals.

 

Advantages: 

  • Accessibility, 

  • Low expense ratios and brokerage fees 

  • Liquidity 

  • Risk management through diversity 

  • Investor dividends

 

Disadvantages:

  • Imprecise price tracking of underlying asset (especially if ETF tracks a futures contract-based asset and has to adjust monthly for contract roll)

  • Gradual price decay over time

  • Subject to reverse splits

  • More volatile than traditional funds

Want to start investing in ETF’s? Start here.

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