How does ETF work for dummies?
You place an order with your broker or online to buy, say, 100 shares of a certain ETF. Your order goes to the stock exchange, and you get the best available price. Limit order: More exact than a market order, you place an order to buy, say, 100 shares of an ETF at $23 a share. That is the maximum price you will pay.
- Interest distributions if the ETF invests in bonds.
- Dividend. + read full definition distributions if the ETF invests in stocks that pay dividends.
- Capital gains distributions if the ETF sells an investment. + read full definition for more than it paid.
ETFs or "exchange-traded funds" are exactly as the name implies: funds that trade on exchanges, generally tracking a specific index. When you invest in an ETF, you get a bundle of assets you can buy and sell during market hours—potentially lowering your risk and exposure, while helping to diversify your portfolio.
ETFs can be some of the best investments for beginners. They're relatively inexpensive, available through robo-advisors as well as traditional brokerages, and tend to be less risky than investing individual stocks.
For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.
Holding an ETF for longer than a year may get you a more favorable capital gains tax rate when you sell your investment.
In order to withdraw from an exchange traded fund, you need to give your online broker or ETF platform an instruction to sell. ETFs offer guaranteed liquidity – you don't have to wait for a buyer or a seller.
- ProShares Bitcoin Strategy ETF (BITO)
- Invesco QQQ Trust (QQQ)
- Vanguard Information Technology ETF (VGT)
- VanEck Semiconductor ETF (SMH)
- Invesco S&P MidCap Momentum ETF (XMMO)
- SPDR S&P Homebuilders ETF (XHB)
- Invesco S&P 500 GARP ETF (SPGP)
ETF issuers collect any dividends paid by the companies whose stocks are held in the fund, and they then pay those dividends to their shareholders. They may pay the money directly to the shareholders, or reinvest it in the fund.
How ETFs can potentially help generate income. Most ETF income is generated by the fund's underlying holdings. Typically, that means dividends from stocks or interest (coupons) from bonds.
What are the top 5 ETFs to buy?
Exchange-traded fund (ticker) | Assets under management | Yield |
---|---|---|
Vanguard 500 Index ETF (VOO) | $431.7 billion | 1.4% |
Vanguard Dividend Appreciation ETF (VIG) | $78.2 billion | 1.8% |
Vanguard U.S. Quality Factor ETF (VFQY) | $324.3 million | 1.3% |
SPDR Gold MiniShares (GLDM) | $6.8 billion | 0.0% |
Exchange-traded funds work like this: The fund provider owns the underlying assets, designs a fund to track their performance and then sells shares in that fund to investors. Shareholders own a portion of an ETF, but they don't own the underlying assets in the fund.
TICKER | NAME | % Change |
---|---|---|
SCHD | Schwab U.S. Dividend Equity ETF | 0.356% |
VTI | Vanguard Total Stock Market ETF | 1.009% |
IJR | iShares Core S&P Small-Cap ETF | 0.336% |
ARKK | ARK Innovation ETF | -0.317% |
In fact, 47% of all such funds have closed down, compared with a closure rate of 28% for nonleveraged, noninverse ETFs. "Leveraged and inverse funds generally aren't meant to be held for longer than a day, and some types of leveraged and inverse ETFs tend to lose the majority of their value over time," Emily says.
When an ETF liquidates, investors generally receive cash distributions equal to NAV, so even if you fall asleep at the wheel, you will receive the fair value of your shares—most of the time. It's worth noting, however, that there have been instances where the process wasn't smooth.
Low Liquidity
If an ETF is thinly traded, there can be problems getting out of the investment, depending on the size of your position relative to the average trading volume. The biggest sign of an illiquid investment is large spreads between the bid and the ask.
If you buy substantially identical security within 30 days before or after a sale at a loss, you are subject to the wash sale rule. This prevents you from claiming the loss at this time.
For ETFs held more than a year, you'll owe long-term capital gains taxes at a rate up to 23.8%, once you include the 3.8% Net Investment Income Tax (NIIT) on high earners.
Unlike mutual funds, however, ETFs are traded on the open market like stocks and bonds. While mutual fund shareholders can only redeem shares with the fund directly, ETF shareholders can buy and sell shares of an ETF at any time, completely at their discretion.
ETFs can bypass taxable events using the in-kind redemption process, while also purging their portfolios of low-cost-basis securities to help portfolio managers avoid realizing large gains if they must sell holdings. But not all ETFs create and redeem shares in kind.
Can I put all my money in one ETF?
Investing in an ETF that tracks a financial services index gives you ownership in a basket of financial stocks versus a single financial company. As the old cliché goes, you do not want to put all your eggs into one basket. An ETF can guard against volatility (up to a point) if some stocks within the ETF fall.
Experts agree that for most personal investors, a portfolio comprising 5 to 10 ETFs is perfect in terms of diversification.
- 9 Safest Index Funds and ETFs to buy in 2024. ...
- Vanguard S&P 500 ETF (VOO -1.36%) ...
- Vanguard High Dividend Yield ETF (VYM -1.53%) ...
- Vanguard Real Estate ETF (VNQ -1.19%) ...
- iShares Core S&P Total U.S. Stock Market ETF (ITOT -1.49%) ...
- Consumer Staples Select Sector SPDR Fund (XLP -1.01%)
Mutual funds and ETFs may hold stocks, bonds, or commodities. Both can track indexes, but ETFs tend to be more cost-effective and liquid since they trade on exchanges like shares of stock. Mutual funds can offer active management and greater regulatory oversight at a higher cost and only allow transactions once daily.
Generally speaking, the best time to trade ETFs is closer to the middle of the trading day rather than the beginning or end.
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