In stock trading, Exchange Traded Funds (ETF) are considered by many to be something of a crossbreed that some people choose to invest in when they buy stocks. They are likened to when you invest in indexes, since ETF’s can go up and down. However, at times they can also appear more like equity.
Indexes reflect a common industry when you want to buy stocks as a collection. When you invest in the Oil Index, for example; you invest in a compilation of similar stocks from oil companies. ETF’s were developed as an index-based investment, which follows the progress of that particular group of stocks—called a basket. The ETF is not designed to outperform the core index, but to imitate its movements.
When you buy stocks in an oil ETF, you do not make money on what you invest in barrels of oil but on the performance of a group of oil companies. One part of the ETF does not necessarily represent the index of the whole.
An ETF acts like equity in that you do not have to invest in a basket of equities to buy stocks or purchase one share of ETF. When purchasing oil ETFs at one price, you do not have to buy stocks in multiple shares to arrive at the desired price.
The trouble with ETF’s is that when you buy stocks, you are basing your decision to invest on the performance of that individual company. An ETF bases its estimate on the portfolio of different companies.
ETFs can be bundles of almost anything—commodities, bonds, stocks, futures and derivatives, to name just a few.
That is the problem with choosing to invest in the ETF.
Consider it the same situation as looking under the hood when buying a used car. You are not a single part of the car, but the whole vehicle. There may be a few minor issues with details of the vehicle, but it may be a worthy purchase overall. That is the decision you have to make.
Deciding to invest in an ETF is a terrific way to diversify when you buy stocks, generate revenue streams and hedge against risk. You can also invest in certain sectors of the market, as opposed to particular stocks or companies.