An exchange-traded fund (ETF) is a type of investment fund that can contain stocks, bonds, commodities or a mixture. Unlike mutual funds, ETFs trade on stock exchanges like stocks, so their price changes throughout the day as they are bought and sold. They aim to track particular indexes, sectors, commodities or other assets, providing an option to diversify investments rather than purchasing one asset at a time.
ETFs have strong liquidity, with popular ETFs that track indexes like the S&P 500 having high trading volume and tight spreads between bid and ask prices. However, some ETFs do not trade often and may be difficult to sell.
Tax Implications of ETFs
How an ETF is taxed depends on its holdings and distributions to shareholders. For instance, a dividend ETF will be taxed on dividends distributed, and selling an ETF may also lead to capital gains tax. The investor’s tax bracket affects the ultimate tax paid.
Regulators require ETF issuers to publish their portfolio compositions daily or quarterly.
Example and Market Activity of ETFs
What is an Example of an ETF?
- An ETF can be structured to track anything from the price of an individual commodity to a large and diverse collection of securities.
- Exchange-traded means that it is readily traded through the exchange system, i.e., the stock market.
Why Might ETFs Not Be Good Investments?
While ETFs typically offer the advantage of diversification and liquidity, they are not without their drawbacks:
- Some ETFs may not trade often, making them harder to sell.
- ETF share prices fluctuate throughout the trading day, unlike mutual funds which only trade once a day after the market closes.