UNDERSTANDING 5 ETF CLASSES
The popularity of exchange-traded funds (ETFs) has increased through the years, primarily because it is cheaper and more liquid than mutual funds. And here are the five ETF classes every investor should know.
Broad Stock Market ETFs
There are ETFs passively investing in broad indexes, including the S&P 500 or the Wilshire 3000. When the underlying index changes, changes to the holdings are only done. Investors won’t encounter any problem looking for a broad market ETF having an expense ratio lower than 40 basis points. But they must be wary of any domestic-focused fund with higher annual fees. Stable and diversified broad market ETFs can serve as a cornerstone of a well-balanced investment portfolio.
Dividend and Bond ETFs
Several ETFs passively track bond indexes like stock funds, making it difficult for individual investors to represent on their own. Barclays Aggregate and Lehman Aggregate Bond indexes designed ETFs fashioned after them, concentrating on US Treasury securities. But less popular index-based ETFs operate the spectrum of corporate bonds, government bonds, and municipal bonds. On the other hand, dividend-based ETFs focus on consistent fixed income. Many diversified funds, even though the dividend rates of corporations change, can provide consistent yields higher than the current 10-year Treasury rates.
Third on the list is foreign ETF. A country can have one or more ETFs focusing only on that nation if their economy is developed enough. Most especially useful to retail investors, these funds can help us access foreign stocks directly via brokerage accounts. These stocks are not accessible unless they have an ADR listed on an American exchange. For this class, expense ratios tend to be greater due to higher costs to access global markets. And the economies of developing countries can be more volatile. It is advisable to cap the allocations at 5% of your portfolio, per nation. Nevertheless, exposure to foreign-based stocks is worth every penny, whether through a single country ETF or a broad international ETF.
These funds do not intend to quantify anything. Rather, it is the other way of saying a fund has certain rules or strategy to follow when it comes to choosing the holdings. Equal weight stocks and usage of financial metrics (cash flow, dividend yield, earnings, and revenues) are two of the common strategies. Bear in mind that some of the ETFs in this class use an active investing strategy similar to mutual funds.
For the longest time, this class has exhibited some of the largest growth in ETFs. Commodity-based ETFs enable direct access to everything, from gold to agricultural commodities. These funds comprise of smaller indexes and schemes, but it cannot be assured the performance of a specific ETF will directly trail the underlying commodity’s performance. Also, certain ETFs focus on up and coming trends such as clean technology and socially-conscious investing. But most funds in this area have fewer holdings and can be more volatile as relatively few companies focus on these trends.
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