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What the ETF! - Some Jargon Demystified

Here's an ETF explainer for you- you're welcome!

What is an ETF?

According to InvestopediaAn exchange traded fund (ETF) is a type of security that involves a collection of securities—such as stocks — that often tracks an underlying index, although they can invest in any number of industry sectors or use various strategies. ETFs are in many ways similar to mutual funds; however, they are listed on exchanges and ETF shares trade throughout the day just like ordinary stock.

GJWHF$ Tribe says: ETFs are baskets of securities that trade on an exchange. It allows you to buy a group of companies instead of just a single company at a time. ETFs can contain all types of investments including stocks, commodities, or bonds; different geographies and sectors.

Why do many GJWHF$ members like ETFs?

There’s a number of us who use ETFs in our investment portfolio, whether it’s a small part of our money or the majority. Here’s the lowdown on the why from some women we spoke to:

1. Low cost + Liquidity – buy and sell when I want to!

ETFs have low cost of trading with ever reducing brokerage costs. Additionally, ETFs are considered a more liquid asset class – liquidity being the ability to convert an asset to cash without substantially affecting its price.

2. Diversification – not putting all my eggs in one basket

Because no one knows for sure what’s going to happen, diversification is a way to manage risk by mixing a variety of investments within a portfolio. With ETFs you can diversify within classes, across asset classes, and geographically.

3. Long-term goals – match index performance

Some of us prefer to have a less hands-on approach to investing yet still want to see our money work for us in the long term. ETFs track indexes to help take the guess work out of investing. There’s no surprises because a good ETF will aim to closely track the performance of the underlying index it invests in. SPY for example, is one of the largest and most traded US ETFs, which tracks the S&P 500 index. The S&P 500 index offers excellent exposure to the US stock market, as it is made up of 500 different stocks.

So How Do ETFs Work?

You can buy and sell ETFs just like ordinary stocks on an exchange.

According to Vanguard(one of the main providers of ETFs): “A market order is a common order type. It's an order to buy or sell at the best currently available price. Because there are no upside or downside limits, a market order usually ensures immediate execution. However, investors might end up trading at a variety of times and prices in some circumstances, such as if the order is large and/or the markets are volatile. Limit orders are a popular way of placing limits on trading prices, for example, if an investor does not wish to sell below a certain price, or buy above a certain price. The investor states the number of shares being traded and the price limits, together with a time limit. If the trade can't be executed within the limits stated, it is cancelled. A stop order is an order to buy or sell a security when its price passes a particular point. It can be used, for example, to limit downside (by selling when the price falls below a certain point) or to lock in profit (by selling when the price rises above a certain price). Block trade – a way to execute large trades outside of the open market, in order to lessen the impact on the market. Block trades take place at an arranged price between the parties concerned.”

What Risks Are Involved?

According to Blackrock (another major ETF provider) investors need to be wary of these risks when it comes to ETFs:

“Capital risk: All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed.

Tax risks: International taxes will impact your return. Do your research to assess how much your ETF returns may be taxed.

Currency risks: ETFs feature some level of currency risks. International ETFs are priced in local currencies, so changes in exchange rate will impact the value of your investment.

Liquidity risk: Liquidity is the ability to turn an investment into ready cash quickly, with no loss in value. Low liquidity of an ETF s can lead to higher trading costs or difficulty in buying or selling the ETF. For a regular investor to assess liquidity, you should look at statistics such as:

1. Average bid/ask spreads which is the difference between the buy and sell price of the ETF. In general, the narrower the spread, the more liquid an ETF is.

2. Average trading volume. In general, the higher the volume, the more liquid an ETF is.

3. Whether the ETF is trading close to its net asset value, an indication of the fair value of each ETF share the closer it is, the more liquid the ETF is.

If you are an investor who is trading a large quantity of shares at once, the liquidity of the ETF’s underlying securities is the more important factor.”

Tracking error risk: potential risk if the underlying securities' performance doesn't match the index they track as well, read more here and here.

The Bottom Line…