In today’s day and age where it is extremely important to diversify your investments, asset classes that let investors achieve this objective are proving to be more favorable than others. As such, you might hear about ETFs, or Exchange-Traded Funds.
We’ve created a simple guide to help you understand essentially what is an ETF and how it helps you to diversify your investments, here are a few important details regarding this financial instrument.
What is an ETF and How Does it Work?
Simply put, an ETF is an assortment of different securities that track an underlying index of commodities. These securities can include conventionally tradable securities such as stocks and bonds, as well as commodities such as gold and diamonds.
An ETF could be designed by a provider and then be traded on an exchange that deals in them. The Chicago Board Options Exchange (CBOE) is one of the most popular trading platforms for ETFs, and it trades ETFs that comprise of a wide variety of assets.
ETFs are an in demand investment because they let you diversify your portfolio quickly and easily. From bonds to stocks, and from precious metals to revered gems, you could invest in any commodities that you like without having to actually own them.
But to understand what is an ETF in its specifics, it is important that you comprehend how it works on a larger level.
It Has the Flexibility of Mutual Funds and the Ease of Stocks
The diversification of an ETF is enough to make it sound like mutual funds, which are also based upon an array of assets in a single investment. But as compared to mutual funds, where a fund manager is actively managing your investment to prove themselves against the market, ETFs are passively managed and simply go by the day to day value of the assets within their index.
This lets you gain gradual but profitable gains in terms of ETFs that are designed with excellence. Since there is not much transactional activity in ETFs, you are also saved from some taxation requirements such as capital gains tax, which you must incur if you trade securities in mutual funds.
With that, ETFs are priced lower than mutual funds. This also gives them an advantage over that asset class.
And perhaps the biggest selling point of ETFs is that they are easily tradable and come with a promise of high liquidity. From a sense of liquidity, this makes them be on par with stocks, if not more.
Are Cryptocurrency ETFs Available?
The CBOE has been vying to become the world’s first exchange to host a cryptocurrency ETF, for which it has filed an application with the U.S. Securities and Exchange Commission (SEC) more than a few times. The latest of these attempts is still awaiting approval.
But since there’s nothing in this world as a free lunch, what is an ETF application without its troubles?
The idea of a Bitcoin ETF was introduced back in 2013. But each attempt to let the ETF get approved by the SEC and get the same kind of credibility as a conventional ETF has gone in vain.
But those who believe in cryptocurrencies are still holding their hopes up, and they look forward to the day where the world’s first cryptocurrency ETF is approved by the SEC.
What to Keep in Mind While Trading ETFs?
While buying ETFs, you need to keep in mind that the ETFs you are dealing in are provided by a credible entity. Some of the ETFs don’t do anything for the investor and provide practically no financial benefits, since they are haphazardly designed to cover the provider’s profile.
That is why, it is important that you look into ETFs that track assets which you have an understanding of. That defines what is an ETF and what level of success is it set to achieve for you.
For instance, if you are one to invest in stocks that belong to biotech companies, then find ETFs that diversify your portfolio in that asset class. Similarly, if your strong suit lies within bonds, then find ETFs that are based upon them.
By knowing the ETF you are investing in, you would be able to make viable investment decisions at all times.
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