Exchange-Traded Fund (ETF) Types and Benefits Explained

What Is a Stock Exchange-Traded Fund (ETF)?

The term stock exchange-traded fund (ETF) refers to a security that tracks a particular set of equities. These ETFs trade on exchanges the same way normal stocks do and track equities just like an index. They can track stocks in a single industry or an entire index of equities. Investors who purchase shares of stock exchange ETF can gain exposure to a basket of equities and limited company-specific risk associated with single stocks, providing them with a cost-effective way to diversify their portfolios.

Understanding Stock Exchange-Traded Funds (ETFs)

An exchange-traded fund is an asset that allows investors to track any number of things, such as indexes, commodities, sectors, or even stocks. Investors can purchase shares in these securities, which trade on stock exchanges. Prices change regularly through the course of a trading day, just like stocks. They are generally considered a more cost-effective and more liquid investment compared to mutual funds.

As mentioned above, ETFs can also track stocks. These are called stock exchange-traded funds. These securities allow investors to gain exposure to a basket of equities in a specific sector or index without purchasing individual stocks. For instance, these ETFs can track stocks in the energy sector or an entire index of equities like the S&P 500. Other tracking methods include the Stochastic Oscillator and the Stochastic Momentum Index.

There is also a group of ETFs that bet against the success of an index or sector, meaning the asset performs well when the underlying asset struggles. Unlike a mutual fund, a stock ETF charges minimal management fees and carries low expense ratios. This makes it an ideal tool for investors of any skill level looking to maintain low costs and generate consistent returns. 

Since they give investors access to a broad range of equities or indexes makes these (and others), stock ETFs are generally considered very diversified assets. This instant diversification limits some of the unsystematic risk associated with company stocks and comes in a simple, low-cost, and tax-efficient tool that can be accessed through most online brokerages.

Benefits of Stock Exchange-Traded Funds (ETFs)

Stock ETFs offer investors a wealth of benefits so it makes sense that fund inflows have increased. In fact, as of January 2024, the ETF market in the United States holds $6.254 trillion in assets under management.

The broad advantages cannot go understated. They are an excellent option for investors who want to diversify their portfolio in a flexible, low cost, and tax-efficient manner. In fact, a growing body of research suggests passive investments like stock ETFs tend to outperform actively managed funds over a long time frame.

Types of Stock Exchange-Traded Funds (ETFs)

The more popular stock ETFs track benchmark indexes like the S&P 500 or Dow 30. For instance, the SPDR S&P 500 (SPY) is consistently the most active asset with an average daily volume exceeding 80 million shares in the 30 days preceding January 12, 2024.

Other styles of stock ETFs adopt a factor-based strategy that accounts for specific attributes like market capitalization, momentum, and value. This subset is a popular strategy known as Smart Beta, which attempts to deliver better risk-adjusted returns than a conventional market capitalization-weighted index.

Sector funds are another popular ETF category that tracks the stocks of a specific industry like energy, financials, and technology.

Here's a breakdown of the various types of ETFs.

• Passive ETFs aim to replicate the performance of a broader index or trend
• Actively Managed ETFs have portfolio managers making decisions about which securities to include in the fund
• Bond ETFs do not have a maturity date, but can provide regular income to investors, depending on the performance of the underlying bonds
• Stock ETFs comprise a basket of stocks (both high performers and growth stocks) to track a single industry or sector
• Industry/Sector ETFs focus on a specific sector or industry to gain exposure to the upside of that industry
• Commodity ETFs invest in commodities without the insurance or storage costs of the physical assets
• Currency ETFs track the performance of currency pairs consisting of domestic and foreign currencies
• Bitcoin ETFs, including spot bitcoin ETFs and bitcoin futures ETFs, offer investors exposure to the crypto market without the need to purchase and store a crypto wallet
• Inverse ETFs aim to earn games from stock declines by shorting stocks
• Leveraged ETFs seek to return some multiples on the return of the underlying investment

The Bottom Line

Exchange-traded funds are similar to mutual funds, in that they represent a basket of securities with exposure to a cross-section of the market. Unlike other types of funds, ETFs can be traded throughout the trading day, providing additional flexibility,