Etfs On Etrade: A Beginner's Guide To Investing

Exchange-Traded Funds (ETFs) are a popular investment option that offers a simple and low-cost way to access the world's investment markets. ETFs are baskets of stocks and bonds, often designed to track well-known market indexes like the S&P 500. They provide investors with an easy and flexible way to buy and sell a diversified range of assets, similar to stocks. With ETFs, investors can gain exposure to a wide variety of investments without needing to purchase individual securities. This makes them an attractive option for those seeking broad market exposure and a convenient way to invest in a diverse range of companies within specific sectors or markets.

ETFs are available on the E*TRADE platform, which offers a comprehensive investment service with a wide range of exchange-traded funds. This paragraph will outline the key advantages of investing in ETFs on E*TRADE and provide an introduction to the process of getting started with this investment option.

Understand the benefits of ETFs

Exchange-traded funds (ETFs) have several benefits for investors. Here are some key advantages:

Trading Flexibility

ETFs are bought and sold during market hours when the markets are open, offering intraday trading flexibility. Share prices are continuously updated during normal exchange hours, allowing investors to know exactly how much they paid to buy or received from selling. This makes it easy to move money between asset classes, such as stocks, bonds, or commodities. In contrast, traditional open-end mutual funds are traded only once per day after the markets close, and investors must wait until the end of the day to know the price.

Portfolio Diversification and Risk Management

ETFs provide investors with diversified access to various markets, sectors, styles, industries, and countries. They can help investors gain exposure to specific sectors or industries they are interested in or have expertise in. With ETFs, investors can also gain exposure to a broad set of markets by investing in just a few ETFs. Additionally, ETFs can be used to manage risk by shorting industry-sector ETFs or buying ETFs that short specific industries.

Lower Costs

ETFs generally have lower operating costs compared to traditional open-end mutual funds. They do not charge a 12b-1 fee, and since client service-related expenses are passed on to brokerage firms, ETF companies have lower overhead costs, which are passed on to investors in the form of lower fund expenses. ETFs also avoid mutual fund redemption fees, resulting in further cost savings.

Tax Efficiency

ETFs are considered more tax-efficient than mutual funds due to structural differences. Mutual funds typically incur more capital gains taxes and pass these taxes on to investors throughout the life of the investment. In contrast, capital gains taxes on ETFs are only incurred when the ETF is sold by the investor. Additionally, when an individual investor sells an ETF, they sell it to another investor, similar to a stock transaction, which does not trigger a capital gains transaction for the ETF.

Compare ETFs with other investment options

ETFs vs. Stocks

ETFs, or exchange-traded funds, are similar to stocks but with some key differences. ETFs are a well-diversified assortment of investments, often including a blend of high-value stocks, municipal bonds, and precious metals. A single ETF can contain dozens or hundreds of different stocks, making them more diversified and therefore less risky than stocks. ETFs can be bought and traded at any time and are taxed at short-term or long-term capital gains rates.

Stocks represent a piece of ownership in a publicly-traded company. They can exhibit different levels of price volatility and liquidity. Stocks are generally riskier but can also provide greater returns than ETFs.

ETFs vs. Mutual Funds

Mutual funds are a common type of investment, often found in retirement accounts. They are a simple way to diversify your portfolio and benefit from professional management. ETFs, on the other hand, are more like stocks in that they can be bought and sold during market hours. ETFs are also more transparent than mutual funds, as you know exactly what you own at any given moment.

ETFs vs. Index Options

Index options are settled in cash, whereas ETF options are traded the same as stock options and are settled in shares of the underlying ETF. Index options cannot be exercised early, but ETF options can.

Summary

Ultimately, the optimal investment portfolio may contain a blend of investment products. ETFs are a good choice if you want to diversify your holdings to reduce risk, whereas stocks may be preferable if you want greater control over your investments and the potential for higher returns. Mutual funds are a safer, simpler option, and index options may be a good choice if you are looking to make a specific trade with a cash outlay.

Learn how to choose an ETF

When choosing an ETF, it's important to have a solid understanding of the role you want it to play in your portfolio. Knowing what to look for is crucial. Here are some key factors to consider:

• ETF's exposure: Understanding an ETF's exposure will help you assess if it aligns with your goals. This includes knowing whether the ETF is actively or passively managed. Active ETFs are generally run by professional managers who aim to beat the market, while passive ETFs (index ETFs) aim to track the performance of an index.
• Underlying investments: Look into what underlying investments the ETF owns. This will give you an idea of its focus and whether it matches your investment objectives.
• Performance: While past performance may not be a reliable indicator, comparing the ETF's performance to its benchmark can provide insights into how well it has achieved its goals.
• Expense ratio: The expense ratio reflects the annual cost of investing in the ETF as a percentage of assets managed. This is an essential factor in evaluating the overall cost of the investment.
• Issuer/Sponsor: The company offering and managing the ETF is another factor to consider. Some investors prefer established providers with strong reputations and long track records, especially for core portfolio holdings.
• ETF structure: There are two main types of ETF structures: those that invest directly in the underlying assets of the index and those that track the index through derivatives. The structure can impact the risk level and management costs of the ETF.
• Trading activity and liquidity: Higher trading volume generally indicates better liquidity, making it easier to buy or sell the ETF.
• Underlying index or asset: Consider the underlying index or asset class the ETF is based on. For diversification, it may be preferable to choose an ETF based on a broad, widely followed index.
• Tracking error: Most ETFs track their underlying indexes closely, but some may deviate. An ETF with minimal tracking error is generally preferable.
• Market position: Look at whether the ETF is an original or an imitation of an existing idea. The first ETF issuer for a particular sector often attracts the most assets.

Additionally, it's essential to understand your needs, the value of the ETF, and the associated risks. Conduct thorough due diligence by researching the ETF's prospectus, analysing its exposure, and evaluating the risks and costs involved.

Understand the risks of investing in ETFs

Like all investments, ETFs come with a set of risks that you should be aware of before investing. Here are some of the common risks associated with ETFs:

Underlying Asset Risk

ETFs invest in a basket of different securities, such as stocks, bonds, commodities, etc. As a result, ETF investors are exposed to any risks associated with the underlying investments. For example, a bond ETF may carry credit risk, default risk, and interest rate risk. It is important to carefully review the risk section of an ETF's prospectus to understand the specific risks associated with a particular fund.

Market Risk

The value of the underlying assets of an ETF may fluctuate, causing the ETF's value to rise or fall. An ETF that tracks a broad market index, such as the S&P 500, is likely to be less volatile than an ETF that focuses on a specific industry or sector. Therefore, it is crucial to understand what the ETF is tracking and the associated risks.

Liquidity Risk

Liquidity refers to the ease with which an investment can be converted into cash without impacting its market price. ETFs derive their liquidity from the liquidity of their underlying securities. Low liquidity in an ETF can lead to higher trading costs and difficulty in buying or selling the ETF. To assess the liquidity of an ETF, investors should consider factors such as bid/ask spreads, trading volume, and how closely the ETF trades to its net asset value.

Tracking Error Risk

Tracking risk occurs when an ETF deviates from the index it is supposed to track due to factors such as management fees, tax treatment, and dividend timing. Physical replication ETFs tend to exhibit larger tracking errors compared to synthetic replication ETFs. Synthetic ETFs use financial engineering techniques to replicate the returns of an index.

Counterparty Risk

Counterparty risk arises in securities lending and synthetic replication. In securities lending, counterparty risk occurs when holdings are lent to another investor for a short period. This risk can be mitigated by setting collateral requirements. In synthetic replication ETFs, counterparty risk can be reduced by collateralizing the fund's swap exposure, although this may lead to higher overall risk.

Tax Risk

While ETFs are generally considered tax-efficient, this does not apply to all types of ETFs. Actively managed ETFs, international ETFs, commodity ETFs, currency ETFs, and those using derivatives may be taxed differently. It is important to understand the tax treatment of a particular ETF before investing.

Closure Risk

On average, about 100 ETFs close each year. When an ETF closes, managers incur various costs, including capital gains, transaction expenses, and legal fees, which are ultimately passed on to investors. To minimize this risk, investors should sell their holdings as soon as the issuer announces the ETF's closure.

Hype Risk

Hype or buzz surrounding certain ETFs can lead to a herd mentality, where investors chase the latest trend without conducting proper due diligence. It is important to stick to your investment strategy and thoroughly research each ETF's methodology and documentation, rather than following the crowd.

While these risks are important to consider, it is also worth noting that diversification can help mitigate some of these risks. By spreading your investments across different sectors, geographies, and asset classes, you can reduce the impact of any single investment's performance on your portfolio. However, diversification does not guarantee returns or eliminate the potential for loss, so careful research and understanding of the risks are crucial.

Learn how to buy ETFs on Etrade

An exchange-traded fund, or ETF, is a basket of many different investments that can be bought and sold during market hours, like a stock. ETFs can offer diversified, low-cost, and transparent access to the world’s investment markets, which may make them a good way to start investing or to supplement your existing investments.

ETFs can be a great way to build a diversified portfolio of investments as the core, or foundation, of a long-term investing program. Many ETFs seek to match the performance of broad markets, including the US stock market, international stock markets, bond markets, and more. This means that by investing in just a few ETFs, you can achieve exposure to a broad set of markets.

ETFs can also help investors pursue more narrow investment ideas, such as those related to specific industries or sectors where they have deep knowledge or interest. ETFs offer options here, too, using a strategy known as thematic investing. This approach uses ETFs whose focus is on specific ideas or segments of the market, which are known as investing “themes”. Some examples of themes include industry sectors like healthcare, technology, energy, and a host of others, as well as specific countries or regions such as Europe, China, or emerging markets.

With so many ETFs available, it’s important to do your homework before buying. Things to check include what’s known as an ETF’s exposure, or what investments it actually owns. You should also learn about the risks that pertain to the ETF's strategy, as well as ETFs as a whole. Also, check the ETF provider—is it a reputable brand? And, of course, you’ll want to investigate the costs, including the fund’s expense ratio and its tax efficiency. The E*TRADE from Morgan Stanley ETF screener and the fund’s prospectus can provide a wealth of information related to these and other due diligence questions.

If you find answers that work for your goals, risk tolerance, and investing strategy, then it’s just a matter of placing your order. After years of development and expansion, ETFs are now important tools for millions of investors, helping them access many different markets and pursue a variety of investing objectives.

Frequently asked questions