What is an ETF? How do they work?

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Next, we will know the basic characteristics of ETFs, in order to decide if we are interested in investing in them. ETFs are a cheaper form of investment than traditional mutual funds, but they have other disadvantages.

WHAT IS AN ETF?

Exchange-traded investment funds or ETFs (exchage-trade funds) are investment funds that are listed on the Stock Market like stocks, which may be mainly because their investment objective is to replicate a stock or fixed-income index. These exchange-traded funds are similar to indexed funds, differing in that the former allow the acquisition or sale of the share not only once a day, but also during the entire daily trading period. WHERE ARE THEY TRADED? The shares are traded on electronic stock markets through real-time information, as well as the automatic dissemination of the prices and volumes at which they are being traded. In this way, you will know the price when executing the purchase or sale.

WHAT ARE THE MAIN FEATURES OF ETFS?

ETFs are mainly characterized by their:
  • Accessibility: Prices are usually minimal.
  • Diversification : The ETF being the replica of an index, composed of a group of assets, the investment is not concentrated in a single asset.
  • Liquidity
  • Transparency: The Stock Exchange calculates and publishes an estimated indicative net asset value that allows the investor to know the evolution of their investment during the trading period.

TYPES OF ETF

  • ETF that follows the evolution of the market: These are those that replicate the benchmark index. Thus, to make the replica, it buys integral shares in the same proportion contained in the index or through the use of derivative financial instruments.
  • Inverse ETFs or inverse exposure to the market: These are those that replicate an index whose evolution is contrary to the market trend, that is, when the index loses value its profitability will be positive and vice versa.
  • Leveraged ETFs: These are those that replicate the index in a certain proportion or leverage. It is important to mention that these, like inverse ETFs, reflect a daily evolution of the index. So, the profitability is calculated with respect to the previous day, not only considering the initial and final value of the period.

HOW DO YOU INVEST IN ETF?

The investor must approach a stock intermediary such as Stock Brokers, in these he will be able to find a list of the different funds. Thus, the intermediary you choose will provide the investor with an identification code, through which they can formulate orders to buy or sell securities. Likewise, it is important to reiterate that to invest in ETFs there is no minimum investment, however, they have commissions that are usually decisive in selecting where to invest.

HOW TO BUILD A PORTFOLIO WITH ETF’S?

Good diversification can have a profound impact on the profitability of our portfolio. ETFs are an easy way to achieve this diversification, as they are flexible and can help us gain exposure to sectors and asset classes that would not otherwise be easy for individual investors. To build a portfolio of ETF’s we must determine the correct asset allocation, since the construction of the portfolio will depend on our investment objectives. Thus, those investors with a long time horizon should have a more aggressive approach, that is, with more weight towards stocks. While investors who want to get their money back in a few years should focus on a more conservative approach, that is, with more weight towards bonds. There are ETFs that offer broad exposure to the markets as they replicate large indices. ETFs are a cheap way to have exposure to the market as a whole, although investors who tend to invest small amounts on a regular basis should take into account the commissions involved in buying ETFs, because the total cost of the investment could exceed what you would have by investing in a traditional mutual fund. Investing in ETFs also helps us invest in undervalued segments of the market, as the market sometimes leaves certain sectors or subsectors below their value. Investing in these sectors can increase our profitability, as these undervalued sectors tend to converge towards their estimated value. Finally, ETFs can help us invest in sectors that were only achievable for institutional investors or high net worth investors such as commodities or currencies.
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