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Wondering About ETFs? The Top 10 Questions About Exchange Traded Funds Answered

By Myles Leva

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Last Updated: January 10, 2022

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ETFs are a popular choice for stable, long-term investments.

However, they can be a bit confusing when you first look into them. To make matters simple, here is a list of the top 10 questions people ask about ETFs. Let’s start by going over what exactly ETFs are.

 

1. What is an ETF?

An Exchange-Traded Fund is a type of security that tracks a specific index, industry, sector, commodity, or other kind of asset.

However, they also, by definition, can be purchased and sold on public exchanges.

ETFs are diverse assets, as they come in many forms and can track many different things. They are a convenient security, as while they are funds, they can still be traded the same way you would trade a regular stock.

Some ETFs simply follow a major index such as the American S & P 500. Others will track a wide range of other securities. In some cases, ETFs are set up to track a specific kind of investment strategy.

 

2. Are ETFs good for beginners?

Yes.

ETFs are an ideal asset class for beginners to invest in. To start, they have low expense ratios, meaning a smaller portion of the ETF’s assets are used for operational purposes. In addition, they make it easier to reach specific investing goals with less effort.

ETFs can easily fit into the investment strategies of beginners and advanced investors alike. They’re highly liquid and offer a diverse range of conveniently packaged investments.

When you stick to the simpler kinds of ETFs such as those that track major stock indexes, they are easy to wrap your head around and have a great track record.

 

3. Are ETFs safer than stocks?

ETFs, like most investments, come with risk.

Just like stocks, ETFs face several kinds of risks. However, a better way to look at it is whether a specific ETF is safer or riskier than a specific stock portfolio.

If you try engaging in self-directed stock investment without first becoming informed on how they work, you are engaging in riskier behavior. Some ETFs are far riskier than others. Given the diverse nature of ETFs, this should be expected.

As a whole, ETFs are no more dangerous than stocks as an investment, assuming you:

  • Understand the value proposition provided by the investment
  • Maintain a level head and refrain from emotion-based decision-making
  • Choose the lower-risk ETFs

If you want to invest in ETFs more safely, you can invest in the ETFs that track historically successful indexes or sectors. In general, more diversity is also associated with risk mitigation. Most financial planners will tell you to diversify your portfolio.

 

4. Can ETFs lose money?

Yes.

ETF costs include commissions, and normally other expenses as well. If you happen to buy an ETF at a premium for whatever reason, there is a strong chance you will be at a loss when you sell it.

In terms of ETF long-term performance, ETFs can be subject to typical investment risks like:

  • Market risk (Prices go up and down, sometimes not in your favor)
  • Exposure risk
  • Tax risk
  • Shutdown risk (Unpopular ETFs may be shut down and liquidated)
  • Trading risk
  • Other risks

 

5. Are ETFs a bad investment?

If you make unwise decisions, yes.

ETFs are not especially risky or difficult compared to other investments. However, not all ETFs are equal, least of all in risk portfolio.

If you make informed decisions, you cannot reasonably call ETFs “bad” as a blanket statement.

 

6. What Are the Types of ETFs?

There are 5 main types of ETFs.

 

1. Equity ETFs

These ETFs track an index of equities covering large caps, small caps, or foreign stocks.

They can be used to target certain sectors like tech stocks, making them a more popular option.

 

2. Bond/Fixed Income ETFs

Bonds are financial instruments representing debts.

They (along with other fixed-income assets) are considered more stable because they provide consistent returns.

 

3. Commodity ETFs

Commodity ETFs track a certain type of commodity.

 

4. Currency ETFs

Currency ETFs track either a single currency or a group of currencies.

 

5. Specialty ETFs

This is a more modern kind of ETF. They are typically used by institutional investors to meet more specific needs.

 

7. How long do you have to hold an ETF before selling?

You can buy or sell an ETF whenever you’d like.

The one time-sensitive issue worth mentioning is capital gains taxes. In the US, long-term capital gains are taxed at a far lower rate. Any investment held for over one year that is sold at a profit will incur long-term capital gains tax.

But in Canada, you simply include 50% of any capital gains earned as regular income.

 

8. Are there any tax advantages to owning an ETF?

If you invest in ETFs within an RRSP, yes.

Overall, there is little difference in the tax responsibilities incurred through ETF or other fund investments. However, some consider ETFs to be a more tax-efficient investment, as they usually generate fewer tax liabilities.

 

9. What’s the difference between an ETF and a mutual fund?

 The two investment classes have a lot in common. Both consist of multiple assets put inside a basket and are popular choices for diversifying portfolios.

 Here are some of the more notable differences between ETFs and mutual funds:

  • ETFs can be traded just like regular stocks but mutual funds can only be purchased at the end of each trading day
  • Mutual funds normally carry higher fees
  • Mutual funds are normally actively managed while ETFs can be actively or passively managed
  • ETF prices fluctuate just like stocks during the trading day, while mutual funds do not

Overall, intra-trade-day liquidity is the most immediate difference between ETFs and mutual funds.

 

10. How is the market price of an ETF determined?

ETFs derive value in two ways:

  • The value of the ETF’s holdings
  • Market supply and demand for the ETF

ETFs are bought and sold during market hours. Their prices fluctuate as the day goes on.

 

Conclusions

ETFs are a relatively stable and beginner-friendly investment class.

They represent a vast array of different opportunities. Compared to stock investing, ETFs offer more immediate diversity and their performance will differ according to their holdings.

Photo by kial.co on Unsplash

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