Exchange traded funds are not created equal. Therefore, if you are planning to invest in such funds, you must be familiar with its different kinds.
Equity Funds
Most exchange traded funds follow indexes or sectors. Some index ETFs imitate an index in its entirety, and others just utilize representative samples. These deviate a bit by using futures, options, and swap contracts. It also includes the purchase of stocks that are sometimes not included in the index.
If this sampling gets too aggressive, it can result to tracking errors. Any ETF with a tracking that lies higher than 2 percent in considered to be actively managed. As ETFs become more and more specialized, this is something investors should watch for.
ETFs let investors enjoy a cheap way to achieve diversification. You can obtain a particular portion of the world’s stocks, a broad sector, or a niche market with the right kind of ETF.
Fixed Income Funds
Most financial professionals recommend that you invest a portion of your portfolio toward fixed income securities like bonds and bond ETFs. The reason is because bonds can decrease the volatility found in a particular portfolio. On top of that, you also gain an additional stream of income.
Just like equity funds, you can also find bond funds. Investors who are not certain about what investment to make should think about bond-market ETFs, which invest in the whole US bond market.
Commodity Funds
Before you invest in commodity ETFs, you should be clear about why you want to invest in commodities. Commodities are known for having a price correlation with equities. Experts indicate that strategic asset allocation accounts for 90 percent of a portfolio’s return.
On the other hand, you should settle for just owning assets across stocks, bonds, commodities, and real estate. You should also diversify within those assets. ETFs are a big help in this department.
You can buy commodity ETFs that track the price changes of particular commodities like gold and oil, or in a commodity stock ETF that invest with stocks, while the latter is highly correlated.
Currency Funds
With the world’s currencies becoming more volatile and the US dollar’s role as a reserve currency slowly fading, investors who want to protect the value of their US-denominated investments will try to find options that offer hedge against a weakening dollar.
You can try and invest in foreign stocks or foreign stock ETFs. On the other hand, this will not provide you with asset class diversification since foreign stocks are generally correlated with the US stocks. a better alternative is to invest in foreign currency ETFs.
It may be focused in a single currency or it may be focused on the broader market, but the idea is to insulate your portfolio from a weakening US dollar. Meanwhile, if the US dollar is strengthening and you own foreign stocks, you can guard the value of those holdings by shorting the same currency ETF.
Real Estate Funds
Income investors who want a little sizzle with their portfolio might want to consider real estate investment trusts (REITs). Whether you choose a fund that invests in a specific type of real estate or one that is broader in nature, the strongest appeal of these funds is the fact that they must pay out 90 percent of their taxable income to shareholders.
