What is an ETF

So what are ETFs exactly? An ETF also called an exchange-traded fund is simply an investment vehicle that is publicly traded on an exchange. Originally, ETFs started to emerge in the beginning of the 90s driven by the simple investment idea of naive diversification. In essence ETFs just invest in an index, like the S&P500. Their original investment purpose was to provide simple investment products for long-term investors.

ETF advantages

As stated above, ETFs allow investors to quickly diversify their portfolio just by buying a single ETF. Additionally, the transaction costs are limited to a great extend. It’s only required to buy a whole index through a single buy order instead of buying multiple shares. Therefore, investment in ETFs can substantially lower the transaction costs for many investors. Moreover, ETFs are very liquid in normal market conditions and can thus be traded quickly in large quantities. Last but not least, ETF investing is easy, fast, cost-efficient and does not require a lot of time effort when building and maintaining a portfolio.

ETF disadvantages

On the other hand, ETFs don’t provide their service for free. In exchange for their services, ETFs charge their clients an annual fee. This fee is called the total expense ratio, shortly TER. This fee is not deducted from an account, but simply charged through adjusting the transaction price of the listed ETF. As a result, it may be more worthwhile in buying all the shares of an index instead of buying the ETF for some investors with huge investment capacities. It should also be noted that despite ETFs are very liquid their underlying investment may not be so. The underlying liquidity may dry up in times of market stress. Unwinding positions in ETFs may then become hard.

Summary

ETTs are listed financial products that allow investors to buy an index, or multiple shares, bonds or other assets in 1 time. ETFs are praised for their cost-efficiency, liquidity and limited required time effort.

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