What is an ETF? Exchange-Traded Fund definition
An ETF is a form of investment instrument which is classified as a security. Most ETFs track real-world assets such as gold, oil, and various other types of commodities.
Investors who acquire ETFs are able to obtain exposure to a certain asset without actually physically needing to buy it. For example, instead of going through the lengthy process of buying gold, having it delivered, and safely storing it, you could simply buy an ETF that tracks gold. This way, you can potentially get the same returns on your investment as if you were actually in possession of the gold itself.
An ETF can also be described as a fund where shares can reap dividends or interest from the investment. Additionally, traditional ETFs have been used for many years in traditional financial markets to track benchmark indexes also. These indexes include the US Dow Industrial Average (DJIA), the NASDAQ-100, and the Standard & Poor’s (S&P) 500.
Indexes are used by stock market investors as benchmarks to assess how their own investment portfolios are doing compared to the performance of the overall market. Asset portfolios, bonds, and commodities are also used as benchmark indexes to determine market performance.
Traditional ETFs: Exchange-Traded Fund listing
Traditional ETFs are traded on exchanges just like stocks but with the added advantage of being able to hold a diversified set of funds at the same low cost as holding individual stocks. ETFs can be described as a financial product which consists of a number of diversified securities.
They are actively traded on a daily basis, and their prices fluctuate throughout the day. One thing in particular that makes ETFs attractive, especially to private investors, is that they can easily trade certain lucrative asset classes in niche markets, which would not otherwise be accessible to them.
Here are the most attractive ETFs of 2019 according to Eric Rosenberg’s research of “Investing for Beginners” dd. March 26, 2019:
1. Best Overall: Vanguard S&P 500 ETF (VOO)
Buying into this fund gives you exposure to 500 of the largest public companies in the United States.
2. Best No-Fee: Fidelity ZERO Total Market Index Fund (FZROX)
This index focuses on the total return of the United States stock market, making it even more diverse than an S&P 500 fund.
3. Best for Active Traders: SPDF S&P 500 ETF (SPY)
This ETF tracks the S&P 500 in real time, active investors use this fund to buy and sell the US stock market in a single trade. SPY launched in 1993 as the first exchange-traded fund.
4. Best for Small-Cap Stocks: iShares Russell 2000 ETF (IWM)
Compared to an S&P 500 fund, managers of the iShares Russell 2000 ETF have four times as many stocks to buy and sell to keep the index fund in-line with the index.
5. Best for US Dividends: Schwab U.S. Dividend Equity ETF (SCHD)
This U.S. Dividend Equity ETF is an excellent choice for investors looking to turn their portfolio into a cash flow. The fund focuses heavily on large companies with stable dividends.
6. Best for Gold: SPDR Gold Trust (GLD)
If you want to invest in gold without going the inconvenience of acquiring the precious metal, then your best option is the GLD ETF.
7. Best for NASDAQ Large-Cap Stocks: Invesco PowerShares QQQ (QQQ)
Ticker symbol QQQ gives you an ETF that tracks the NASDAQ 100 Index. The NASDAQ 100 is made up of the 100 largest stocks on the NASDAQ stock exchange, traditionally a home for many technology companies.
8. Best International: Vanguard FTSE Developed Markets (VEA)
VEA follows the FTSE Developed All Cap ex US Index. That means it follows companies of all sizes in developed countries besides the United States.
How to invest in ETFs?
Like all investments, ETFs come with risk. Typically, riskier investments lead to higher returns, and ETFs tend to follow that pattern. Diverse, broad market funds and funds focused on bonds tend to offer the lowest risk. Commodity, option, and narrower funds usually bring more risk and volatility to the table.
Investment decisions should align with relevant financial goals. Investors need to be aware of their own risk tolerance, if they can afford to lose some or all of the investment, and how the investment choices fit in with the overall financial plan.
It is also important to take risk and volatility into account. Some investors are fine with taking on risky assets betting that they will pay off big returns. Other investors prefer to avoid major ups and downs and are more concerned with preserving capital and a steady income.
And finally, It is worth keeping an eye on the fees. In August 2018, Fidelity released two new ETFs that are 100% fee-free. These cutting-edge ETFs are a very new concept. Prior to that, competitive ETFs from companies like Vanguard, Fidelity, and Schwab led the market’s lowest fees with some under 0.1%. The most expensive ETF, according to Bloomberg, charges 9.2%. It is absolutely critical to compare the fees and other features of various ETF before buying.
There is no minimum investment amount for ETFs and they primarily track a certain index while also attempting to replicate its performance. ETFs work by issuing and redeeming (buying back) shares of stock, however, these types of transactions are not categorized under sales.
Instead they are considered “in-kind” transactions, which mean that capital gains from the trades do not need to be distributed to shareholders. Sometimes though, a minimal amount earned from ETFs trading is given to shareholders. One of the primary benefits of this type of trading is that ETFs do not typically result in a significant tax liability.
ETF’s critical advantage
Another advantage of ETFs is that they can be passive investment instruments. This means you do not need to pay fees to investment professionals for management and monitoring. Also, when you purchase ETF shares, you are actually acquiring shares in a portfolio. This portfolio is linked to a market index, and the ETF strictly replicates the performance of its underlying index. Additionally, since ETFs are not managed by a person, there is no risk of a fund manager potentially losing trades against a benchmark index.
What is a Crypto ETF?
A Crypto ETF is a proposed fund that would keep track of the bitcoin benchmark index while also replicating its performance, much in the same way as traditional ETFs do. This would let traders with brokerage accounts make investments in Bitcoin (BTC), with the added benefit of not needing to go through the technical process of purchasing the cryptocurrency and storing it securely.
Moreover, the types of Bitcoin ETFs proposed so far, such as the one by Winklevoss Twins, had Bitcoin (BTC) as its underlying asset. Therefore, an investor buying such an ETF would also indirectly be buying Bitcoin. However, instead of holding the actual cryptocurrency in their digital wallets, the investor would have a portfolio with a bitcoin ETF. Despite this fact, it would be somewhat the same as holding bitcoin itself, since the ETF would be tracking the cryptocurrency price.
The primary distinction between purchasing Bitcoin (BTC) and acquiring a Bitcoin ETF is that, with the latter, the investor would be holding a regulated investment that is tradable on exchanges without needing to deal with secure storage.
How will Bitcoin ETFs affect the price?
With the introduction of Bitcoin ETFs, there’s a good chance that cryptocurrencies could be added to a mainstream investor’s portfolio. Institutional investors prefer to trade and hold regulated assets and crypto ETFs could encourage investments in digital currencies.
A number of market analysts believe that Bitcoin ETFs could help increase overall cryptocurrency adoption, while also significantly driving prices upwards. One of the reasons crypto ETFs could lead to a surge in cryptocurrency prices is because they could potentially increase scarcity and liquidity. Usually, when an asset or store of value becomes scarce, there’s a substantial increase in its price.
Compared to when the Bitcoin futures contracts were launched, it can be argued that, with the entry of Bitcoin ETFs into the market, there will be a more sustainable price increase. The reason for this is because many investors shifted from the physical crypto market to the derivatives market shortly after Bitcoin futures contracts were introduced.
SEC Bitcoin ETF
Several applications for a Bitcoin Exchange-Traded Fund have been sent to the US Securities and Exchange Commission for review and approval. The demand for a Bitcoin ETF in the crypto community is also increasing day by day, however, the federal watchdog has rejected many crypto ETF applications due to “significant investor protection issues” and various other regulatory concerns.
The SEC has also cited “liquidity and valuation” issues associated with crypto ETF proposals, which resulted in the denial of such requests. Moreover, almost all Bitcoin ETF applications so far have requested that BTC’s price be tracked through BTC futures contracts offered by financial market companies such as the CME Group and the Cboe.
Due to BTC futures contracts having fairly low liquidity and trading volumes, in addition to such contracts following (instead of leading) volatile spot exchange rates, the SEC has not approved Bitcoin ETFs.
The latest story on SEC’s rejection decision concerns the VanEck/SolidX Bitcoin ETF which filed in December 2018. SEC extended a rule change proposal allowing the nation’s first bitcoin Exchange-Traded Fund, pushing the decision deadline to February 27, 2019. The proposal was first submitted by money manager VanEck and blockchain startup SolidX who partnered with the Cboe exchange in mid 2018. Under SEC rules, a decision on the proposal cannot be delayed any further, meaning that the result in February was supposed to be either an approval or rejection of the ETF. Since there is no approval announcement, it was rejected as a result.
Most crypto traders were not experienced enough to grasp the supply and demand effects of BTC futures contracts, which partly contributed to the market crash after the launch. With Bitcoin ETFs however, investors will be actually trading Bitcoin itself. This, in turn, could drive prices higher and more sustainably in the long-term.