An exchange traded fund (ETF) is a basket of securities — such as stocks, bonds, currencies, or commodities — that can be bought and sold in a single trade on an exchange. It generally tracks the performance of an index, may charge less fees, and offer targeted exposure to a specific market segment, such as an asset class, geography, sector, or investment theme.
In essence, ETFs are funds that trade like stocks with the diversification benefits of mutual funds. In one trade, they may offer diversified, low-cost, transparent and tax-efficient exposure to companies across the globe. But unlike traditional mutual funds, which are priced once a day at the close of trading, ETFs are priced continuously throughout the trading day and can be bought or sold at any time — allowing investors to react to market conditions and news in real-time and to execute trades quickly and efficiently.
Understanding the benefits of ETFs is an important step toward determining whether ETFs can be an appropriate choice for your portfolio
ETFs generally track an index, offering exposure to a specific segment of the market such as:
Because most ETFs are passively managed, they typically have lower management fees and operating expenses compared to mutual funds. Transaction costs are minimized due to the low turnover of most ETFs and the indexes they track. When fees and expenses are low, investors can keep more of their returns.
ETFs provide one of the easiest ways to diversify a portfolio.
They provide access to many companies or investments in a single trade, removing single stock risk — the risk inherent in being exposed to just one company. The ETF structure helps to lower the risk that a select number of individual stocks could hurt overall portfolio performance.
ETFs benefit from two sources of liquidity:
ETFs are generally more tax efficient than other investment vehicles due to the ability to transfer securities in and out of the portfolio in the most tax-efficient manner, via the in-kind creation/redemption process. Because ETFs generally track market indexes, turnover is generally low, resulting in fewer capital gains and lower taxes. Additionally, any associated capital gains taxes are paid at the time of final sale, offering greater control on the timing of tax consequences.
ETFs can be bought through an online brokerage account at their current market price, at any time during the trading day. There are no minimum holding periods, and investors can employ a wide range of trading techniques — such as buying on margin, short selling, and placing limit orders — to react to market movements.
Most ETF holdings are fully transparent and available daily, which means that investors can see exactly what assets the ETF holds and how its performance is being impacted by changes in the underlying assets. This can help investors make more informed investment decisions with greater accuracy.
Like any investment, ETFs carry certain risks that investors should be aware of before making a decision to invest:
Using a due diligence process, investors should consider their investment objectives and risk tolerance before investing in ETFs. Be sure to visit the fund’s prospectus for more information on the risks associated with a particular ETF.
One example of an ETF is the SPDR® S&P 500® ETF (SPY) — the largest,2 most traded,3 and most liquid ETF in the world.4 This ETF tracks the S&P 500 Index, which is a broad-based index that consists of 500 of the largest publicly traded firms in the United States, spanning all major sectors. By investing in SPY, an investor can gain exposure to the performance of the entire US stock market, which can help to diversify their portfolio and potentially reduce the impact of market volatility.
ETFs have grown exponentially since 1993 when State Street Global Advisors launched the SPDR® S&P 500 ETF Trust (SPY), the first US-listed ETF. Today, investors use ETFs to precisely meet their individual portfolio needs, from finding income and gaining broad market exposure, to lowering costs and investing in difficult-to-reach markets.
State Street Global Advisors launched the first US-listed ETF: SPDR® S&P 500 ETF Trust (SPY)
Total number of global exchange traded funds available. 5
Global assets under management in ETFs and ETPs 5
1 ETFGI, as of December 31, 2022.
2 Bloomberg Finance L.P., as of December 12, 2022.
3 Bloomberg Finance L.P., as of December 12, 2022.
4 Bloomberg Finance L.P., as of December 12, 2022.
5 ETFGI, as of December 31, 2022.
Authorized Participant (AP)
A US-registered and self-clearing broker-dealer who meets certain criteria and signs a participant agreement with a particular ETF sponsor or distributor to become an “authorized participant” of the fund. APs are often associated with large and influential investment banks, and are scrutinized for their integrity and operational competence as they are the only parties who transact directly with an ETF.
Creation and Redemption Process
The process whereby an ETF issuer takes in and disburses baskets of assets in exchange for the issuance or removal of new ETF shares.
An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
The degree to which an asset or security can be bought or sold in the market without affecting the asset’s price. Liquidity is characterized by a high level of trading activity.
The market where shares of an ETF are created or redeemed.
A market where investors purchase or sell securities or assets from or to other investors, rather than from issuing companies themselves. The New York Stock Exchange and the NASDAQ are secondary markets.
Investing involves risk including the risk of loss of principal.
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All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.
Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions.
Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs.
Diversification does not ensure a profit or guarantee against loss.
Passive management and the creation/redemption process can help minimize capital gains distributions.
There can be no assurance that a liquid market will be maintained for ETF shares.
While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.
Because of their narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies.
Non-diversified funds that focus on a relatively small number of [stocks, issuers, countries] tend to be more volatile than diversified funds and the market as a whole.
Foreign investments involve greater risks than U.S. investments, including political and economic risks and the risk of currency fluctuations, all of which may be magnified in emerging markets.
Currency Risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.
Low volatility funds can exhibit relative low volatility and excess returns compared to the Index over the long term; both portfolio investments and returns may differ from those of the Index. The fund may not experience lower volatility or provide returns in excess of the Index and may provide lower returns in periods of a rapidly rising market. Active stock selection may lead to added risk in exchange for the potential outperformance relative to the Index.
The returns on a portfolio of securities which exclude companies that do not meet the portfolio's specified ESG criteria may trail the returns on a portfolio of securities which include such companies. A portfolio's ESG criteria may result in the portfolio investing in industry sectors or securities which underperform the market as a whole.
A Smart Beta strategy does not seek to replicate the performance of a specified cap-weighted index and as such may underperform such an index. The factors to which a Smart Beta strategy seeks to deliver exposure may themselves undergo cyclical performance. As such, a Smart Beta strategy may underperform the market or other Smart Beta strategies exposed to similar or other targeted factors. In fact, we believe that factor premia accrue over the long term (5-10 years), and investors must keep that long time horizon in mind when investing.
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Passively managed funds invest by sampling the index, holding a range of securities that, in the aggregate, approximates the full Index in terms of key risk factors and other characteristics. This may cause the fund to experience tracking errors relative to performance of the index.