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ETFs, exchange-traded funds, are among the most popular investment avenues. Whilst individual stocks track the performance of a particular publicly traded company, an ETF will track a broader selection of securities. This type of multi-faceted exposure can help towards a more balanced portfolio that is less vulnerable to sharp price swings should a particular company fall short on an earnings report or negative criticism.
ETFs commonly track popular global indexes (passive) like the UK’s FTSE 100, the industrial giant Dow Jones or the S&P 500, which is dense with leading blue-chip companies. ETFs are inherently similar to mutual funds in the markets they choose to track, but the key difference in ETF trading is how they’re traded. Unlike more traditional funds that might have always been a popular play for long-term yields, exchange-traded funds are bought and sold in the active hours of the stock market, meaning they can be bought and sold from your chosen brokerage in real-time throughout exchange hours. This is unlike mutual funds, which are only traded once a day.
Dividends are effectively slices of profit dished out to investors based on company performance. Should a company succeed or exceed its quarterly targets, it can pay a dividend of its profit to its shareholders - shaped as a hands-free bonus for its valued investors.
So how does this work for ETFs?
Not all ETFs pay out dividends, but most do. Typically, dividends are paid out monthly or at another chosen interval, sometimes quarterly. Investors can easily sift out funds that don’t offer dividends by simple research, normally even the very name of the fund should clear up any confusion, and looking into past performance should reveal possible dividend amounts. Beyond that, dividend yields should be a critical focus for ETF investors, which obviously vary from fund to fund depending on the companies under focus. For most savvy ETF investors, dividends paid out are generally reinvested to make the most out of compounding interest.
As briefly mentioned, ETFs differ from mutual funds in their fluidity of trading. They can be bought at any time during the opening hours of the stock market, allowing for a heightened level of precision when it comes to buying and selling at the market price, and a more tightened grip on volatility. Mutual funds are only traded once a day, so while a trader can log a request to buy or sell, it will only go through at a certain window - normally the end of the trading day. ETFs, in that sense, are often viewed as a more flexible investment strategy, allowing the trader to sell at any time during usual trading hours, and use live trading tools like market orders or limit orders to carry out trades.
Above all else, the key difference between ETFs and individual stocks revolves around one word - diversification. ETFs cover a wide breadth of bases. Instead of tracking a particular company, an ETF might track an index like the S&P 500. Investors are exposed to a more transparent picture of an economy, sector or industry rather than honing in on the risks or fluctuations associated with investing in an individual company.
Whilst ETFs tracking benchmarks like the S&P or FTSE (UK) are incredibly popular with more risk-averse strategies, growing popularity in more specialist ETFs, narrowing in on innovative industries and emerging asset classes like green energy or cloud computing, is evident.
Starting out in the investment landscape isn’t easy. It’s a bewildering conundrum of information, and it’s easily distorted through differing online narratives. Before making investment decisions, beginners must be aware of the associated risks and market conditions. Weighing up the long-term performance of many companies might be ok for those who don’t find analysing financials tedious.
Still, for beginners, ETFs remove the legwork and allow investors the chance to profit through a wider lens of exposure. For beginners, understanding what an ETF is and the movement behind ETFs is a starting block into the more complex world of technical and fundamental analysis.
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