Exchange-traded funds (ETF) - definition and pros and cons

Read our introductory guide to exchange-traded funds, what they are, and pros and cons.

Helen Cockle

If you have tipped your toe in the world of investment funds, you might have come across what is called 'ETFs'. This stands for exchange-traded funds - these funds can be of interest to an investor because they combine the diversification potential of a mutual fund with the ease of stock trading. This is why we've compiled this short guide to ETFs and how they work.

Someone looking at exchange rate on their phone
If you have tipped your toe in the world of investment funds, you might have come across what is called 'ETFs'.

Exchange-traded funds - explained

ETF describes a bundle of assets traded on an exchange. As opposed to mutual funds, which are priced at the conclusion of a trading day, ETFs can be sold or bought throughout the course of the day (much like an individual stock). The ETF trading market is also quite versatile. The ETFs trade happens at different values, however, their fees tend to be at the lower end of the spectrum. For an ETF fund, the provider purchases a basket of underlying assets, (eg stocks, bonds, currencies, or commodities). Then, a unique tracker gets created for each basket, with their performance tracked by the ETF. The ETF provider is then free to sell shares to investors. These ETF investors then own shares of the actively managed ETFs they have bought shares of, however, not of the funds' but not its underlying assets. An exchange-traded fund (ETF) is traded for market-determined prices.

Exchange rates on phone and display
ETF describes a bundle of assets traded on an exchange.

Different ETFs

There is a number of different ETFs that might be worth considering. Here is a list of a few important types:

  • Bond ETFs - Bond ETFs do not have a maturity date and investors benefit from regular interest payments generated by individual bonds underlying the fund. This is a relatively low-risk investment option.
  • Stock ETFs - These investments consist of a basket of stocks and are less risky than individual company shares. This is a good long-term investment because it allows the investor to track their stocks over time.
  • Commodity ETFs - Some ETFs are based on underlying commodities rather than eg bonds. You can either invest in an ETF tracking the value of the physical commodities or one investing in companies that deal with the commodities.
ETF tracking
You can either invest in an ETF tracking the value of the physical commodities or one investing in companies that deal with the commodities.

Is ETF investment a good idea?

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ETF investments allow you to diversify across a number of markets and industries. This process can be streamlined by investing in pre-diversified funds. ETF also has good transparency levels, traded on exchanges which makes them easy to track. The fund’s holdings are displayed publicly every day to help you track your funds.

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Commission fees might incur when trading ETFs, as these funds are being traded on exchange, you might have to pay commission fees. ETFs also are not as liquid as other types of investment or assets. If market prices are fluctuating, getting rid of funds can be more difficult and stocks trading slow. ETFs can also close, forcing you to sell and potentially losing out.

Should I get into ETF trading?

If you are confident in the world of the stock exchange, ETFs can be an interesting option and an easy way to diversify. If you have invested in different funds, successful funds can balance out the loss in other funds so it can be a relatively low-risk way into the stock market.

Wall St street sign
If you are confident in the world of the stock exchange, ETFs can be an interesting option and an easy way to diversify.

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