Securities are financial instruments that investors trade on the open market in hopes of generating a profit. These financial instruments include stocks, options contracts, and bonds, and they usually fall into one of four categories: debt securities, equity securities, derivative securities, and hybrid securities.
An exchange-traded fund (ETF), however, differs from these primary categories because it usually contains a mixture of investment types and tracks an index, commodity, sector, or another asset. In this sense, ETFs are similar to mutual funds but can be traded like stocks through traditional broker-dealers and online brokers. Popular ETF brokers include Charles Schwab and Interactive Brokers. Alternatively, investors can purchase ETFs through online platforms such as Wealthfront and Betterment.
ETFs contain multiple assets, so they are useful investment tools for those looking to diversify their portfolios. Some ETFs contain thousands of stocks across diverse industries. Others are limited to a particular sector or country. For instance, a petroleum-focused ETF is comprised of oil and gas company stocks.
As marketable securities, ETFs can be purchased and sold by investors. ETFs have become more popular in recent years due in part to a combination of investor demand and technology enhancements that have allowed them to be traded at lower costs. People invested more than $7.7 trillion in ETFs worldwide in 2020, which was up from $6.2 trillion in 2019. Only $720 billion was invested in ETFs globally in 2008.
There are four primary types of ETFs: bond ETFs, which include government and corporate bonds; industry ETFs, which track specific industries; commodity ETFs, which invest in commodities such as gold and crude oil; and currency ETFs, which invest in foreign currencies. There are also inverse ETFs, which are funds that try to take advantage of stock declines through a strategy called shorting. Shorting is the selling of stock before an expected decline and repurchasing it for a cheaper price. The majority of inverse ETFs, however, are exchange-traded notes structured as bonds.
Specific ETFs include sector ETFs, such as energy (XLE), financial services (XLF), and biotech (BBH) as well as the SPDR Dow Jones Industrial Average, Invesco QQQ, and iShares Russell 2000. The SPDR S&P 500 is the best-known and oldest ETF. It tracks the S&P 500 Index and may contain each of the 500 stocks that comprise the S&P. Investing in all of these stocks can have cost benefits, including fewer broker commissions and low expense ratios. ETFs also can be managed passively, which requires less time and effort than investing in a range of securities separately.
Buying and selling ETFs may have disadvantages, however. ETFs that focus on a particular industry limit portfolio diversification and may result in increased risk if that industry is in decline. ETFs also can lack liquidity, meaning they can be difficult to convert to cash. Investors should study the differences in the bid price and the asking price of ETFs for at least a week to avoid purchasing illiquid investments. As a rule, attractive ETFs typically have relatively small spreads between the bid and asking prices.
