What Are ETFs?
What are ETFs?
ETFs or exchange-traded funds are funds managed by investment companies and banks like Vanguard, Charles Schwab, Chase Bank, Bank of America, Sofi, and etc. These funds are comprised of the shares of many companies and are collected in one large investment pool. Some of the more famous and well-known ones are the index funds. Index funds are funds that measure specific market indexes like the S&P 500, Nasdaq 100, and the Dow Jones Industrial average.
All ETFs invest in companies that target specific companies in order to meet specific investment goals. The S&P 500 invests in the top 500 companies listed on the US stock market with example ETFs being the VOO or SPY. The Nasdaq 100 includes companies from various industries except for the financial industry, like commercial and investment banks. These non-financial sectors include retail, biotechnology, industrial, technology, health care, and others.
The ETF, QQQ, follows the Nasdaq 100 and ranks in the top 1% of large-cap growth funds. Since its formation in 1999, QQQ has demonstrated a history of outperformance, consistently beating the S&P 500 Index. The Dow Jones Industrial Average is a price-weighted measurement stock market index of the most 30 prominent companies listed on the stock market, which includes the likes of Apple, Boeing, Home Depot, and more. One ETF that follows this index is the fund DIA.
Why should you invest in ETFs?
Along with the bigger and more famous index fund ETFs, there are thousands more ETFs to invest in that all have their own purpose investment-wise. There are ETFs like JEPI and SPHD, whose investments are managed in such a manner that they invest in some of the S&P 500 and aim to pay monthly dividends while having less volatility than ETFs that completely follow the S&P 500. There are ETFs like NOBL that invest specifically in companies called dividend aristocrats, which means they have a long history of raising their dividend payouts every year. There are even ETFs like BLOK that invest in companies involved with the development of blockchain technology for cryptocurrencies.
Pros of investing in ETFs!
There are both upsides and downsides when it comes to investing in ETFs. One of the biggest upsides is that ETFs are managed in such a way that the rise and fall of the share price of an ETF are noticeably less volatile than when it comes to investing in single stocks. This is because the companies that manage ETFs regularly look at the stocks held inside of an ETF and look to see which companies were winners and which were losers. After they do that they might sell shares of some of the losers and buy some more of the winning stocks or vice versa, based on how the managers value the stock.
Cons of investing in ETFs!
The biggest downside to investing in ETFs is the management fee or as they are officially called the ETF’s expense ratio. Since the company that creates and manages the ETF is providing a service, they expect to get paid. The expense ratio is a fee where the managers of an ETF charge a certain percentage of your holdings every year you hold the shares of the ETF. The index funds mentioned earlier charge some of the lowest ETF fees on the stock market. The S&P 500 ETF called VOO charges an expense ratio of 0.03%. The Nasdaq 100 ETF QQQ charges an expense ratio of .20%. The Dow Jones Industrial Average ETF DIA charges a fee of 0.16%.
Beware though, there are some ETFs out there that even though you might think they charge a small amount in expense ratios, they are technically quite high and can cost you thousands and even tens of thousands of dollars in fees over time!
Here’s a video from the YouTube channel, Honest Finance, explaining expense ratios and how they eat away at your investments.
Disclaimer: I am not any sort of investment or financial professional giving any sort of legal advice. I’m just some guy trying to teach other people about how they might navigate the financial world.
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