ETF (Exchange-Traded Fund) is an investment fund that allows you to buy a large set of individual stocks or government and corporate bonds in one purchase. ETFs can also be explained as a large grocery basket holding together many various types of groceries, but instead of sugar, meat, beans, rice, cooking oil, and a chocolate bar, the basket was filled with stocks or bonds and you buy them together in one go.
Now, you could imagine ETFs being similar to mutual funds, which is another way to buy many stocks at the same time but there are some differentiating traits. The mutual funds are “actively managed” which means they are actively traded by a fund manager.
Instead, many ETFs are monitored by algorithms that track an entire economic sector or index, like the S&P 500 or the US bond market. This difference of active and passive management is the determiner of the different MERs (Management Expense Ratios) which represents the percentage of the value of the entire fund that is deducted annually to cover the fund’s operating expenses. These MERs are different for both ETFs and mutual funds due to the kind of management explained above. The mutual funds’ MERs can even get to 2% while the ETFs’ is usually between 0.05% and 0.25%.
What types of ETFs are there?
There are various types of ETFs one can buy. There are not as numerous as stars in the sky but they are enough to find those that will suit your needs and goals, and as you might have imagined, the number grows every day.
a. Stock Market Tracking ETFs
This type of ETF has attracted the most investors due to mirroring the indices but also the fact that the investors see them as a way to own a fraction of the American economy. These ETFs track indices like S&P 500 which is for the 500 publicly traded American companies with the highest market capitalisations.
For those who want to diversify their portfolios, they also look into the S&P 400, or the Russell 2000 which track mid-cap and small-cap publicly traded companies.
The benefit of this type of ETF is that they provide automatic diversification and you can easily track past performances by looking at past market activity. The popular index ETFs include the Invesco QQQ and the iShares Russell 3000.
b. Sector Tracking ETFs
If you want to focus on a certain favorite industry of the economy instead of the whole of it, you will need to get a sector tracking ETF. The financial institutions, Standard & Poor’s (S&P) and MSC have developed a taxonomy of the global economy that puts all the publicly traded companies in one of 11 main sectors which is named the “Global Industry Classification Standard (GICS)” and the sectors are:
- Communication Services
- Consumer Discretionary
- Consumer Staples
- Health Care
- Information Technology
- Real Estate
However, some ETFs even go further and track the sub-sectors of these 11 main sectors which from largest to smallest are categorised as Industry Group, Industry, and Sub-Industry. This means that if you want to focus on a certain area like crude oil, there is an ETF for that.
c. International ETFs
For the investors who want to invest in international stocks, several types of ETFs are composed of company stocks from other countries like any other ETFs.
d. ETFs that focus on developed markets
The developed markets are the markets of the countries with the most established economies. These are countries with established rules of law and are technologically advanced in comparison to other countries in other parts of the world. Countries like Germany, Japan, Canada, and Australia. A developed market ETF would give you exposure to all developed markets, and BlackRock’s iShares MSCI EAFE ETF (EFA) is a great example.
e. ETFs that focus on emerging markets
These are ETFs that focus on countries with relatively low per capita average salaries that are less politically stable than developed markets but open to international investment such as China, Brazil, and Turkey. However, the risk of investing in such markets is greater than in developed markets, but the risk is somewhat mitigated when an ETF invests in many emerging markets and not just one.
f. ETFs that focus on the economy of one country outside the US
For example, BlackRock’s iShares MSCI Japan ETF (EWJ) allows investors the ability to “access the Japanese stock market in a single trade” as a promise. Their iShares MSCI South Korea ETF (EWY) allows investors to get access to Samsung stocks, the Galaxy maker, one of the most difficult stocks to own but also provides you with a Hyundai Motors stock for diversification’s sake.
g. Thematic ETFs
Like some business acts recently, some ETFs also exist to make a statement. The thematic ETFs only track the companies that are environmentally friendly and are usually dubbed “ESG” (environmental, social, and corporate governance). Others act as financial trend spotters, like the ETFs offered by a company called Global X, which offers narrowcast ETFs such as a “Millennials Thematic ETF,” “Autonomous & Electric Vehicles ETF,” and “Longevity Thematic ETF.”
Yes, you should let your cool exploration do its thing, but be aware that most, if not all, of the thematic ETFs, have MERs that approach or equal those of mutual funds because they are actively managed.
h. Complex ETFs
There are some… I mean many, many ETFs that do not necessarily bet on the stock market going up, and you should know that. Some of these ETFs are called leveraged ETFs and inverse exchange-traded funds. And, unless you are absolutely and fully sure of what you are doing and would, say, explain derivatives to a 97-year-old grandmother and a 4-year-old son sitting on the same couch, avoid these ETFs like you would for a naked wire on a wet floor. However, don’t be afraid Spiders. “Spiders” is how many refer to Standard and Poor’s Depositary Receipts (SPDR), some of the very first ETFs. The SPDR S&P 500 was the largest ETF in the world for many years.
How to buy ETFs
As mentioned and explained above, ETFs work and behave a lot like individual stocks, in that they can be bought and sold all the trading day on stock exchanges right alongside your Teslas, Apples, and Netflixes.
If you have been trading stocks, congrats, you already pretty much know how to trade ETFs as well. Whether you are that or just a novice to the stocks or even the entire investment world, you have come to the right place.
Ndovu is here to level the wealth playground and allow anyone with any level of expertise in the stock and relative markets to succeed. All you do is answer a few questions and our algorithm will let you know what type of investor you are, what level of risk you can tolerate and what type of assets you should start investing in.
With free registration, personalised customer service, educational materials to educate yourself along the way, you can simply start investing in various ETFs on the Ndovu platform as soon as now from as little as $10 by just signing at ndovu.co. Our staff will engage with you right away about the next steps.
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Ndovu is an online platform owned and run by Waanzilishi Capital Limited, an investment adviser licensed by the Capital Markets Authority of Kenya.