When you invest in an ETF (exchange-traded fund), you are buying into a pooled investment vehicle, similar to a mutual fund. But unlike mutual funds, which investors can buy or sell only once per day, ETFs are traded throughout the day on organized stock exchanges, just like common stock.
Most ETFs are passively managed, which means a portfolio manager references a published index to determine which securities to hold and how to weight those securities in their portfolios. However, some ETFs are actively managed—that is, the portfolio manager makes investment decisions for the fund. Some actively managed ETFs, known as active semi-transparent ETFs, shield their full portfolio holdings and only reveal full holdings on a monthly or quarterly basis. An ETF can fill almost every investment niche, from small-cap stocks to emerging market bonds to commodities. With so many choices, it helps to know more about the types of ETFs available.
There are a vast number of ETF choices on the market today.
To determine which ones are right for your portfolio, it's helpful to look at common ETF types, the investment strategies associated with them, and their benefits, risks, and costs.
What are equity ETFs?
There is a wide array of equity ETFs to choose from, so knowing about the various subtypes can help you find one that fits your portfolio. Depending on the index tracked by the ETF, it may own stocks issued by companies from around the world or it may limit its investable universe to companies in the United States. Some ETFs allow companies of all styles and sizes, while others limit their holdings based on the particular characteristics of a company. Because there are so many variables, the number of stocks held by an ETF can range from less than 25 to over 7,000.
Here are some examples of equity ETFs:
International ETFs own stocks in companies headquartered outside of the United States.
Sector ETFs own stocks in companies pursuing similar types of business or offering similar products and services.
Dividend ETFs own stocks in companies that have a history of paying dividends to shareholders.
Market-cap index ETFs
Market-cap index ETFs select and weight stocks based on the size of each company's market capitalization—the total value of its shares.
What about ETFs with complicated strategies?
The number of strategies offered by ETFs has proliferated in recent years. While an ETF with a particular strategy may be exactly what you want in your portfolio, keep in mind that some strategies can be quite complex. It’s a good idea to make sure you understand the process an ETF uses to select and weight securities before you make an investment decision.
Here are some examples:
What are non-equity ETFs?
In addition to stocks, an ETF can hold non-equity securities, such as bonds, commodities, and currencies.
The main types of non-equity ETFs are:
Hold a portfolio of bonds issued by government treasuries, municipalities, private companies, and/or financial institutions.
Invest in raw materials (e.g., agricultural goods, energy, and precious metals) via either futures contracts or metals held in secure vaults. These tend to be higher in risk and are not suitable for all investors.
Track an index of a single currency or a basket of multiple currencies.
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