Factors to Look at in an ETF Fund

The term ETF fund is a bit of a misnomer since ETF means "exchange-traded fund." These portfolios of stocks, bonds, commodities or even currencies are commonly referred to simply as ETFs. ETFs are indexes of a given amount of trading devices, and they trade each day at the value of the sum of all of their parts. There are many types of ETFs, from extremely focused to very diversified, and each will offer its own benefits.

Diversification of the ETF

All factors of an ETF start at one common place: whether it is diversified or focused. A diversified ETF attempts to hold investment options across many platforms, such as a mix of stocks and bonds from many indexes. Diversified ETFs are common for novice investors who would typically invest in a mutual fund. An ETF typically offers slightly easier trading and lower taxes year-to-year than a mutual fund.

There are some ETFs that are not like mutual funds at all, however. These ETFs are extremely focused in their intent. For example, some currency ETFs track the value of only one foreign currency. Investors choose this option because it is easier than investing in the currency directly, but the effect is typically the same. If the currency performs poorly compared to expectations, then the ETF will perform poorly.

Risk Levels of the ETF

Less diversified ETFs tend to be more risky. They rely on the performance of only one or two trading instruments. More diversified ETFs tend to spread the risk. Risk levels on ETFs are more complicated than this simple comparison, however. Risk can also be associated with the exact focus of the ETF.

For example, a bank ETF tracks all of the investments of one particular bank. There are two general categories of bank ETFs. Local bank ETFs, those that track the investments of small, domestic banks, tend to be less risky. ETFs tracking global banks that engage in riskier investments themselves will present higher risk opportunities to investors as well. 

Profit Potential of the ETF

With most investment opportunity, greater profit potentials exist with higher risk ETFs. This is true particularly in commodity ETFs. Commodities are among the most volatile trading tickets on the market. They are affected not only by market conditions but also by the shipping industry and logistical factors. A bad winter, for example, can falsely inflate the cost of oranges very easily. A delay in a grain ship making it to port can represent losses on a grain trade. Commodities also tend to reflect among the highest potential for profits. Other risky investments, such as hedge fund ETFs, also present high risk high reward situations. 

Investors seeking a low risk, low reward option may consider bond ETFs. ETFs made up of a variety of local and federal bonds rarely ever lose their value, and they present predictable returns on an annual basis. Bond ETFs are more likely to trade close to their original price over their lifetime, making it easier to sell the ETFs at any point rather than awaiting a high in the market.

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