As we all know, a comprehensive assessment of the available options is the mark of a good investor. And when it comes to ETFs, there is absolutely no dearth of the said available options.
Exchange-Traded Funds or ETFs may trade like stocks, but under the hood, they more resemble mutual funds and index funds, which can vary greatly in terms of their underlying assets and investment goals.
So as a brief and succinct introduction, listed below are a few common types of ETFs (just note that these categories aren’t mutually exclusive):
Passive & Active ETFs:
ETFs are classified as either passively managed or actively managed. Passive ETFs are designed to mimic the performance of a larger index, such as the S&P 500, or a more specialised targeted industry or trend.
Gold mining equities are an example of the latter category: as of February 18, 2022, there are around eight ETFs that specialise in gold mining businesses, omitting inverse, leveraged and low-asset-under-management funds.
Actively managed ETFs do not normally track an index of stocks, instead of relying on portfolio managers to choose which assets to include in the portfolio. These funds provide advantages over passive ETFs, but they are more costly to investors.
Stock ETFs:
ETFs that track a specific industry or sector are called stock (equity) ETFs. A stock ETF could, for example, track automotive or international equities.
The purpose is to provide a wide range of perspectives on a certain industry, one that includes both high-performing enterprises and newcomers with potential for development. Stock ETFs are less expensive than stock mutual funds and don't require the investor to actually own the stock.
Commodity ETFs:
Commodities, such as gold, coffee, and crude oil, are raw items that may be bought and sold. Commodity ETFs allow you to combine various securities into a single investment.
It's also vital to understand what's within these ETFs: do you own real stockpiles of the item in the fund, or do you hold shares in firms that create, transport, and store these goods?
Are there any futures contracts in the ETF? Is the item classified a "collectable" by the Internal Revenue Service? These characteristics can have significant tax consequences as well as varying levels of risk.
Such ETFs offer a few advantages of their own:
a) firstly, they diversify a portfolio, thereby making it much easier to hedge against market downturns. Commodity ETFs, for example, can provide a safety net in the event of a stock market downturn;
b) secondly, owning commodity ETF shares often turns out to be cheaper than owning the commodity itself, owing to the fact that ETF shares don’t require insurance or storage.
Bond ETFs:
Bond ETFs are utilised to offer investors a steady stream of income. The performance of the underlying bonds determines how their earnings are distributed.
Examples include government bonds, business bonds, and state and local bonds, often known as municipal bonds. In contrast to their underlying assets, bond ETFs do not have a defined maturity date.
They frequently trade at a discount or a premium to the price of a genuine bond. Bond ETFs might be a good low-risk substitute for stock ETFs.
International ETFs:
Foreign equities, as well as national stocks and bonds, are commonly advised for diversifying a portfolio. International ETFs are often considered as convenient — and generally less hazardous — forms of investment in overseas markets. Individual nations or national blocs may be the target of these investments.
Industry/Sector ETFs:
Industry or sector ETFs are ETFs that focus on a specific industry or area. An energy sector ETF, for example, will contain companies involved in the energy business.
Industry ETFs are meant to give investors exposure to an industry's upside potential by tracking the performance of companies within that sector.
These are particularly valuable for investors watching economic cycles, as some sectors perform better during expansions and others perform better during contractions.
An example of this is the IT industry which has seen a recent flood of capital. These have a greater risk profile than broad-market ETFs. At the same time, because ETFs do not entail direct ownership of shares, the downside of erratic stock performance is also limited.
Industry ETFs are often utilised to move in and out of sectors throughout economic cycles. Sector ETFs, such as gold ETFs, can provide your portfolio exposure to a sector that interests you while reducing the risk of investing in a single business.
Currency ETFs:
Currency ETFs are pooled investment vehicles that monitor the performance of currency pairings that include both local and foreign currencies. These are used for a variety of reasons, including
a) speculating on currency values depending on political and economic changes in a nation,
b) diversifying a portfolio or hedging against volatility in forex markets by importers and exporters, and
c) hedging against the fear of inflation. Bitcoin even has its own ETF.
Inverse ETFs:
Inverse ETFs attempt to profit from stock declines by shorting shares. Shorting is the practice of selling stock and then buying it back at a lower price in the hopes of a price decline.
An inverse ETF uses derivatives to short a stock. They are essentially bets on the market's demise. As investors should be aware, many inverse ETFs are exchange-traded notes (ETNs) rather than genuine ETFs. An ETN is a bond that trades like a stock and is backed by a bank or other issuer.
Leveraged ETFs:
A leveraged ETF tries to generate returns that are multiples of the underlying assets (e.g., 2 or 3). These products leverage their profits by using derivatives such as options or futures contracts. Leveraged inverse ETFs, which target an inverted multiplied return, are also available.
So if you’ve reached the end of this article you must realise: there is an ETF for everyone, and now you’re fully equipped to find the right one for yourself!
Written by-Devika Mishra
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