What are ETFs?

Understanding ETFs

ETFs offer many benefits and, if used wisely, are an excellent vehicle to achieve an investor’s investment goals. Essentially a basket of securities that you can buy or sell through a brokerage firm on a stock exchange, ETFs are offered on virtually every conceivable asset class from traditional investments to so-called alternative assets like commodities or currencies. In addition, innovative ETF structures allow investors to short markets, to gain leverage, and to avoid short-term capital gains taxes.

In essence, ETFs are an easy way to invest that tends to have low upfront cost, that is flexible yet also simple, transparent and easy to trade. Learn how ETFs can make your money do more for you minus the relative complexity of many traditional investment products.

ETFs are an easy way to invest that tends to have low upfront cost, that is flexible yet also simple, transparent and easy to trade.

How do ETFs work?

Trading like a stock: Just like a stock, ETFs have ticker symbols and can be bought or sold during market hours at real-time prices.

Share creation & redemption: Unlike regular stocks, the number of ETF shares can change daily, as providers issue new shares or redeem existing ones. This ability keeps the market price of ETFs in line with their underlying securities.

Price alignment: Although designed for individual investors, institutional investors help keep ETF prices in line with their underlying assets through a mechanism called “creation units.”

Liquidity: This process ensures that ETFs remain liquid and closely track the value of the index or assets they represent.

Advantages of ETFs

• Easy to trade — Flexible trading liquidity — Buy and sell during market hours with ease, benefiting from liquidity that allows timely execution and portfolio adjustments.

• Transparency — most ETFs are required to publish their holdings daily; this is not always the case, for example in a managed fund, where the portfolio manager has the discretion to choose not to reveal the investments in the fund.

• More tax efficient — ETFs typically generate a lower level of capital gain distributions relative to actively managed mutual funds

• Trading transactions — because they are traded like stocks, investors can place a variety of order types (e.g., limit orders or stop-loss orders) that can't be made with mutual funds

Disadvantages of ETFs

• Trading costs — if you invest small amounts frequently, there may be lower-cost alternatives investing directly with a fund company in a no-load fund

• Illiquidity — some thinly traded ETFs have wide bid/ask spreads, which means you’ll be buying at the high price of the spread and selling at the low price of the spread

• Tracking error — while ETFs generally track their underlying index fairly well, technical issues can create discrepancies

• Settlement dates — ETF sales are not settled for 2 days following a transaction; that means as the seller, your funds from an ETF sale aren't technically available to reinvest for 2 days

Institutional investors play a key role in maintaining the liquidity and tracking integrity of the ETF through the purchase and sale of creation units, which are large blocks of ETF shares that can be exchanged for baskets of the underlying securities.

ETFs make accessing markets easy

ETFs offer access to a wide range of investments—from individual Southeast Asian markets to global bond asset classes and commodities like gold. Even markets that are traditionally difficult to access, such as emerging economies, can be invested in easily through ETFs.

Investing strategies

You can conventionally invest your assets using stock index and bond ETFs, and adjust the allocation in accordance with changes in your risk tolerance and goals. You can also add alternative assets, such as gold, commodities, or emerging stock markets. 

Ready to explore ETF investing?Discover ETF opportunities with CMC Invest and start building a diversified portfolio today.

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