Exchange-traded funds (ETFs) are one of the biggest asset classes in the world. Data shows that ETFs had more than $5.45 trillion in assets in 2020. Inflows into the asset class have grown since then. Interestingly, ETFs had about $102 billion in 2000. In this article, we will look at what ETFs are and how you can create a well-diversified portfolio made up of ETFs. 

What is an ETF?

An ETF is a financial asset that is designed to track one or more assets. These funds hold the assets and are then listed in an exchange like the New York Stocks Exchange (NYSE) or Nasdaq. Some ETFs hold thousands of assets, while others hold just one. For example, the ProShares Bitcoin ETF (BITO) holds just one asset, Bitcoin futures listed at the CME.

The goal of ETFs is to give investors a chance to invest in a diversified portfolio. For example, Invesco QQQ is an ETF that enables investors to invest in the Nasdaq 100 index. In other words, by investing in QQQ, you have basically invested in all the 100 companies in the index. 

ETFs are mostly favored by long-term investors rather than day traders. This is because they tend to have minimal volatility than equities or other individual assets.

Biggest ETF companies

There are hundreds of ETFs in the United States. Interestingly, most of these funds have been created by a handful of large Wall Street companies. 

The biggest player in the industry is Blackrock, which is the biggest asset manager in the world with more than $9.5 trillion in assets. It entered the ETF business when it bought iShares from Barclays at the height of the Global Financial Crisis (GFC). 

Blackrock is followed by Vanguard, a company that was started by John Bogle. The firm has more than $7 trillion in assets and is beloved for its business model. Unlike Blackrock, Vanguard is owned by its customers, which makes its fees relatively low.

Other companies in the ETF issuing business are State Street, Invesco, Schwab, and ProShares.

Types of ETFs

There are primarily two main types of ETFs in existence today: passive and active ETFs. Passive ETFs are the most popular types of ETFs. 

They are known as passive simply because they are created to track an index. For example, the Invesco QQQ fund tracks the Nasdaq 100 index, while the Vanguard S&P 500 (VUX) ETF tracks the S&P 500 index. When a company creates such an ETF, it buys all stocks in the index at the respective weighting. It can only sell the stock when the ETF itself sells it.

An active ETF is one that does not track an existing ETF. The fund manager will typically buy and sell stocks depending on their performance and future outlook. A good example of an active ETF is the Ark Innovation Fund (ARKK), which is managed by Cathy Wood. The stock holds tech companies that the fund manager believes will do well in the future. 

Another key difference between active and passive funds is that they are typically more expensive to invest in than passive funds. That is because the fund will need to pay the investing team. Managing passive ETFs is not all that expensive. For example, the ARKK fund has an expense ratio of 0.75%, which is substantially higher than the average ratio of 0.15% of passive funds.

Types of ETFs by assets

Another way to categorize ETFs is by the assets that they invest in. In this, there are several types of ETFs, including:

  • Currency ETFs – These are ETFs that track currencies. For example, the Invesco Dollar Index Bullish Fund tracks the greenback. There are other ETFs that track currencies like the euro, Japanese yen, and British pound.
  • Bond ETFs – These are ETFs that track bonds of all types, such as corporate and government bonds. Corporate bonds can be categorized into high-yield or junk bonds, convertible bonds, and investment-grade bonds.
  • Stock ETFs- These are ETFs that track stocks like Amazon and Google. They are grouped into several classes like growth, value, and dividend stocks. Others are categorized by sectors like technology, financials, and energy.
  • Commodity ETFs – These are funds that track commodities like gold, silver, and crude oil.
  • Leveraged ETFs – A leveraged ETF is a fund that holds a certain asset and then uses debt to amplify its performance. These ones are riskier for most investors.
  • Cryptocurrency ETFs – These are ETFs that track digital currencies or their futures.

How to invest in ETFs

Investing in ETFs is a relatively easy thing to do. All you need is to create an account with one of the popular brokers like Robinhood, Schwab, TD Ameritrade, and Fidelity. 

After you have done that, you should do research about the ETFs. There are several things you need to look at when investing in the fund. First, look at the type of fund that you want to invest in. 

Second, look at the historical performance of the fund. While past performance is not an indicator of future performance, investing in an ETF with a good track record is recommended. 

Third, you should then look at fees charged by different ETF companies. This is important because different companies charge a different expense ratio for the same product. Therefore, going for a cheaper ETF is highly recommended. 

Finally, you should look at the holdings of the funds to ensure that you have a diversified portfolio. For example, investing in Vanguard S&P 500 ETF and Schwab S&P 500 ETF is investing in the same product. As such, you cannot say that you have diversified your portfolio.

Summary

ETFs offer an excellent method to make money in the financial market. In this article, we have looked at what ETFs are, how they work, the biggest providers of ETFs, and how you can invest in them.