How does ETF work for dummies?
ETF is a type of pooled investment vehicle that invests in a basket of securities. A pooled investment vehicle is one in which multiple investors take part. Each investor adds money to the pool. This pooled money is then invested in a basket of securities by the manager of the pool – the Fund Manager.
- Interest distributions if the ETF invests in bonds.
- Dividend. + read full definition distributions if the ETF invests in stocks that pay dividends.
- Capital gains distributions if the ETF sells an investment. + read full definition for more than it paid.
ETFs or "exchange-traded funds" are exactly as the name implies: funds that trade on exchanges, generally tracking a specific index. When you invest in an ETF, you get a bundle of assets you can buy and sell during market hours—potentially lowering your risk and exposure, while helping to diversify your portfolio.
Exchange-traded funds (ETFs) can be an excellent entry point into the stock market for new investors. They're cheap and typically carry lower risk than individual stocks since a single fund holds a diversified collection of investments.
Higher Management Fees
Not all ETFs are passive. Some ETFs are actively managed, meaning they're managed by a fund manager whose goal is to outperform the market. Actively managed funds often have higher fees since they require management to guide the fund.
ETF trading generally occurs in-kind, meaning they are not redeemed for cash. Mutual fund shares can be redeemed for money at the fund's net asset value for that day. Stocks are bought and sold using cash.
| ETF | Assets under management | Expense ratio |
|---|---|---|
| Invesco QQQ Trust (ticker: QQQ) | $244 billion | 0.2% |
| VanEck Semiconductor ETF (SMH) | $14 billion | 0.35% |
| Consumer Discretionary Select Sector SPDR Fund (XLY) | $19 billion | 0.09% |
| Global X Uranium ETF (URA) | $3 billion | 0.69% |
Key Takeaways. Exchange-traded funds have different tax rules, depending on the assets they hold. For most ETFs, selling after less than a year is taxed as a short-term capital gain. ETFs held for longer than a year are taxed as long-term gains.
You expose your portfolio to much higher risk with sector ETFs, so you should use them sparingly, but investing 5% to 10% of your total portfolio assets may be appropriate. If you want to be highly conservative, don't use these at all.
One of the ways that investors make money from exchange traded funds (ETFs) is through dividends that are paid to the ETF issuer and then paid on to their investors in proportion to the number of shares each holds.
What do you actually own when you buy an ETF?
Exchange traded funds work like this: The fund provider owns the underlying assets, designs a fund to track their performance and then sells shares in that fund to investors. Shareholders own a portion of an ETF, but they don't own the underlying assets in the fund.
An exchange-traded fund, or ETF, allows investors to buy many stocks or bonds at once. Investors buy shares of ETFs, and the money is used to invest according to a certain objective. For example, if you buy an S&P 500 ETF, your money will be invested in the 500 companies in that index.
The choice comes down to what you value most. If you prefer the flexibility of trading intraday and favor lower expense ratios in most instances, go with ETFs. If you worry about the impact of commissions and spreads, go with mutual funds.
ETFs may close due to lack of investor interest or poor returns. For investors, the easiest way to exit an ETF investment is to sell it on the open market. Liquidation of ETFs is strictly regulated; when an ETF closes, any remaining shareholders will receive a payout based on what they had invested in the ETF.
Typically, the issuer will give a minimum of 30 days' notice to allow investors to find an alternative ETF, or to alter their investment strategy. If you own ETF shares, you will receive cash equivalent to the value of your holding on the day of liquidation (not the value on the last day of trading).
Interest rate changes are the primary culprit when bond exchange-traded funds (ETFs) lose value. As interest rates rise, the prices of existing bonds fall, which impacts the value of the ETFs holding these assets.
If you sell an equity or bond ETF, any gains will be taxed based on how long you owned it and your income. For ETFs held more than a year, you'll owe long-term capital gains taxes at a rate up to 23.8%, once you include the 3.8% Net Investment Income Tax (NIIT) on high earners.
ETFs, in that sense, are often viewed as a more flexible investment strategy, allowing the trader to sell at any time during usual trading hours, and use live trading tools like market orders or limit orders to carry out trades.
Key Takeaways. ETFs can be safe investments if used correctly, offering diversification and flexibility. Indexed ETFs, tracking specific indexes like the S&P 500, are generally safe and tend to gain value over time. Leveraged ETFs can be used to amplify returns, but they can be riskier due to increased volatility.
- Vanguard Real Estate ETF (VNQ 0.23%) ...
- iShares Core S&P Total U.S. Stock Market ETF (ITOT 0.83%) ...
- Consumer Staples Select Sector SPDR Fund (XLP -0.09%) ...
- iShares 0-3 Month Treasury Bond ETF (SGOV 0.02%) ...
- Vanguard Utilities ETF (VPU 0.08%) ...
- iShares U.S. Healthcare Providers ETF (IHF 0.86%) ...
- Schwab U.S. TIPS ETF (SCHP -0.08%)
What is the average return on an ETF?
| S&P 500 ETF | 1-yr | 3-yr |
|---|---|---|
| Returns after taxes on distributions | 25.85% | 9.56% |
| Returns after taxes on distributions and sale of fund shares | 15.87% | 7.70% |
| Average Large Blend Fund | ||
| Returns before taxes | 22.32% | 8.83% |
| Symbol | Name | AUM |
|---|---|---|
| SPY | SPDR S&P 500 ETF Trust | $480,845,000.00 |
| IVV | iShares Core S&P 500 ETF | $428,245,000.00 |
| VOO | Vanguard S&P 500 ETF | $397,549,000.00 |
| VTI | Vanguard Total Stock Market ETF | $361,141,000.00 |
If you buy substantially identical security within 30 days before or after a sale at a loss, you are subject to the wash sale rule. This prevents you from claiming the loss at this time.
An ETF follows a particular index and the securities are present at the same weight in it. So, it can be zero when all the securities go to zero.
ETF dividends are taxed according to how long the investor has owned the ETF fund. If the investor has held the fund for more than 60 days before the dividend was issued, the dividend is considered a “qualified dividend” and is taxed anywhere from 0% to 20% depending on the investor's income tax rate.
