You may hear about the S&P 500 ETF, but do you know what is an ETF? It is an extremely famous and diverse investment tool, with many options suitable for all traders and investors. In this article, we will learn together what an Exchange Traded Fund is, what an the pros/cons of ETF investment funds in 2026.
What are ETFs?
An ETF (Exchange-Traded Fund) is an investment fund that simulates the volatility of a group of assets such as technology stocks, energy, commodities, bonds or cryptocurrencies, without directly owning them. ETFs are structured to include various financial assets, from stocks of a company to currencies and commodities. ETFs are listed and traded on stock exchanges.
ETF will help investors with limited capital access many different types of assets at low costs. This is also a time-saving solution for individual investors, while ensuring diversity in their investment portfolio. One of the 2024 biggest additions to the ETF market is ETF Bitcoin (ProShares Bitcoin Strategy ETF) and ETF Ethereum.
ETFs offer investors and traders the opportunity to invest in different sectors of the economy, rather than individual assets. They also help traders diversify their investment portfolios, take advantage of trends, and avoid short-term income tax.
For example, you may have heard a lot about the development of AI and artificial intelligence recently, but you may not know how to find suitable companies to invest in, as this is still a relatively new field. In this case, an investor can consider the Global X Robotics & Artificial Intelligence ETF.
Benefits from ETF funds bring to the market
1/ Increase liquidity
ETF prices are displayed in real time and traded like stocks. raders can buy and sell ETF shares at any time during trading hours.
It helps increase market liquidity to the participation of market makers. These people buy and sell assets in the fund portfolio, helping the price of ETF certificates close to their real value. This activity increases liquidity for asset classes such as stocks, bonds, commodities and cryptocurrencies.
2/ Promote long-term market growth
ETFs simplify investment products, making them more accessible to more people. Even large investment firms and institutions can invest in ETF shares. ETFs are financial products that can represent multiple other trading instruments, including fixed-income securities.
This promotes long-term growth of financial markets. By the end of 2021, global ETF capitalization reached 9.94 trillion USD, with an average growth rate of 25.6% per year from 2002 to 2021.
ETFs are currently doing well in at least two roles:
- Ensure profit for investors.
- Attract capital into the financial market.
How an ETF operate?
ETFs, or Exchange-Traded Funds, are like investment funds with a twist. They trade on exchanges like stocks. Here’s a simplified breakdown of how an ETF works:
Creating an ETF
This is a crafty process where financial institutions or investment funds pick a variety of assets (stocks, bonds, and other securities) to form a diverse portfolio. They’re not all from the same industry or sector, and they’re chosen to catch the eye of investors.
ETD issuing and trading
When it comes to issuing and trading, these assets are bundled into a basket and sold as shares. Each share is a piece of the pie, representing a fraction of the total assets.
For example, the CRYPTO101 ETF might have a total value, or Net Asset Value (NAV), of $1,000,000. If this is split into 100,000 shares, each one costs just $10. This way, you can own a slice of a bigger investment picture for a small price.
These shares are then traded on major exchanges, and they’re fully regulated, so you don’t have to worry about the nitty-gritty details.
Keeping the price balanced
If the ETF’s price veers off from the actual asset value, there are two ways to correct it:
- Creation: If the ETF’s price is too high, new shares are created by buying assets at a lower market price and selling them at the ETF’s higher price, pocketing the difference.
- Redemption: If the ETF’s price is too low, shares are bought back and dismantled to retrieve the underlying assets, which are then sold at the market’s higher price, pushing the ETF’s price up.
These actions, driven by supply and demand, ensure the ETF’s price reflects its true worth. So, whether you’re a newbie or a pro, ETFs can be a smart addition to your investment strategy.
How many kinds of ETF
Let’s explore 4 different ways we can categorize ETF:
By asset type
Here, ETFs are sorted based on the goodies they hold. You’ve got your stock ETFs for the equity enthusiasts, bond ETFs for the safety seekers, and commodity ETFs for those who like tangible assets. Mixed ETFs are the buffet tables of the investment world—offering a little bit of everything. Take the SPDR S&P 500 ETF Trust (SPY) or the Vanguard Real Estate ETF (VNQ)—they’re like specialized chefs cooking up a storm in their respective corners of the market.
By geography
This is where location comes into play. Whether you’re rooting for the home team with a US ETF or looking for a taste of Europe with an EU ETF, there’s a map for your investment journey. Fancy a trip to the Land of the Rising Sun? The iShares MSCI Japan ETF (EWJ) has got you covered. Or maybe you’re drawn to the old-world charm of the Vanguard FTSE Europe ETF (VGK).
By management strategy
- Passive ETFs: These are the set-it-and-forget-it types, like the Vanguard Total Stock Market ETF (VTI), mirroring a portfolio’s performance without meddling with its makeup.
- Active ETFs: The opposite of their passive pals, these ETFs, such as the ARK Innovation ETF (ARKK), have managers tweaking and tuning the fund to seize market moments, adding a dash of spice or a pinch of salt as needed.
By underlying asset form
- Spot ETFs: They’re like the farm-to-table restaurants of the investment world. The iShares Gold Trust (IAU) is a prime example, where buying the ETF is akin to owning a piece of the actual asset.
- Futures ETFs: These are the fortune tellers, linked to the value of futures contracts. The ProShares Bitcoin Strategy ETF (BITO) and the Valkyrie Bitcoin Strategy ETF (BTF) are betting on what’s to come rather than what’s in hand.
When it comes to impact, Spot ETFs often steal the show, as they require the actual purchase and storage of assets, directly influencing supply and demand.
So, whether you’re a seasoned investor or just dipping your toes in the financial waters, understanding the classification of ETFs can help you navigate the vast ocean of investment options. Remember, each type of ETF has its own story to tell, and it’s up to you to choose which narratives resonate with your investment goals.
Popularity of ETFs in traditional financial markets
ETFs, or Exchange Traded Funds, were created in the United States in 1993 by Nathan Most and Steven Bloom with the development of the SPDR S&P 500 ETF. However, it did not gain much attention at that time because people thought it was just a financial tool.
Economist Harry Markowitz was one of the first to lay the foundation for building Exchange Traded Fund indexed portfolios. His idea was to create an investment fund listed on the stock exchange based on the most popular stock market index in the world, the S&P 500. Today, the SPDR ETFs have become the largest ETF in the United States with a total value of over $43.3 billion.
In 1996, iShares was launched and provided ETF portfolios on various stock market indices in Europe, Asia, and the United States. iShares is the largest ETF investment fund in the world, with over 300 options for traders and investors. The emergence of iShares allows small retail investors to also to trade and access ETF investment funds.
The success of ETF indexed portfolios led to the creation of ETFs dedicated to commodities and gold ETFs, which were introduced in 2004 under the name Gold SPDR GLD. Traders can see the annual performance of this ETF investment fund in the image below.
Today, about $3 billion is traded on the ETF market every day, making it one of the most liquid and competitive markets, similar to Forex. Let’s take a stroll down memory lane. The development history of ETFs is nothing short of impressive.
From a novel concept to a powerhouse in the financial markets, ETFs have grown to a staggering global value of over $10,000 billion. That’s right, billion with a ‘B’! And guess what? The United States is the MVP here, holding more than 70% of that value, which is around $7,191 billion.
While the US has been basking in the ETF spotlight, other markets are just starting to get their share of the action. It’s like a global talent show where everyone’s waiting for their turn to shine.
The Pros of ETF
After learning about ETFs, below are the benefits of investing in the ETF (Exchange Traded Funds):
Cost effective
One of the main benefits of ETFs is their cost-effectiveness. Traders do not have to pay membership or withdrawal fees. However, transaction fees are negligible, much lower than investment fees.
The fund is passively managed so management costs are lower than actively managed funds. Investors do not have to buy/sell stocks regularly, so they will save an effective amount of money during the stock trading process.
They also provide better tax control over capital gain tax, as investors can choose the timing of their tax payments.
Diversification
ETFs offer diversity since they mimic various financial assets, allowing traders to access multiple financial markets with just one trading tool. An ETF usually invests in many stocks according to an index.
ETFs allow investors to diversify their investment portfolios, helping to protect them against market fluctuations. Buying ETFs is a safe choice for beginners investing in the stock market, without requiring in-depth knowledge of each specific stock.
Convenience and transparency
ETFs also provide benefits like investing in stocks. Investors have access to all available features, including buy/sell orders, margin trading, stop loss orders, limit orders… All the fund’s holdings are made public every day. This helps investors closely monitor their portfolio.
In addition, investing in a basket of securities (index investing) also limits the phenomenon of market abuse and manipulation.
Flexible
Like investing in stocks, ETFs allow investors to buy and sell at any time of the day, only ending when the market closes. There are many options that allow investors to enter the market with market orders or limit orders.
Attract foreign capital
ETF is the fastest way for foreign investors to access the Vietnamese stock market. Through ETF funds, foreign investors will also indirectly own stocks that have reached the maximum foreign ownership ratio that they cannot buy directly.
The Cons of ETF
When selling an ETF certificate, traders may have to wait up to two days for the payment to be processed. This means that the seller cannot use their trading account to reinvest for two days.
Does not match index
Investors still have to pay ETF management fees, so their investment returns will never exactly match the index the ETF emulates. The price at which investors buy and sell shares in the fund may also vary relative to the net asset value of the underlying index, reducing returns. Therefore, investors need to evaluate the costs to pay before opening positions in ETFs.
Poor liquidity
Some thinly traded ETFs have quite high bid/ask spreads, increasing transaction costs. Stocks issued by small companies can also be considered thin market and it has low liquidity.
Lower return than investing in stocks yourself
The dividend yield may be lower than if buying individual stocks, because this is the average of the dividends of all companies in the ETF basket. ETFs are directly affected by the net asset value of the underlying assets.
The spread is the hidden cost that traders have to bear when buying or selling an ETF position.
Volatility risk
Despite the diversification that an ETF provides, the investment can still be affected by volatility in the markets and losses during bear markets. This risk can increase with the specialization of an ETF – a fund that focuses on a small niche market is likely to be more volatile than a larger, broader fund.
Price difference
Although exchange-traded funds (ETFs) try to closely track the prices of the underlying assets, price discrepancies can still occur. The ETF’s investment portfolio may deviate from the portfolio of securities constituting the reference index (for various reasons such as index simulation techniques, price fluctuations of the securities in the portfolio).
This causes the fund’s return to be different (higher or lower) than the return of the reference index. For investors in ETFs, deviation from this reference index (tracking error) is a potential risk factor.
What is the difference between ETF funds and investment funds?
- Investment funds pool money from various investors and are entrusted to professional fund managers or investment companies to invest in companies. On the other hand, ETF funds are bought and sold directly on the stock market like stocks.
- Investment funds are suitable for both active and passive investors, while ETF funds are more suitable for passive investors.
- Investment funds typically aim to achieve higher returns than stock indexes, while ETF funds aim to achieve returns that are in line with the stock indexes they mimic.
Conclusion
In conclusion, by ETF, investors can invest in crypto in a simpler and safer way, without having to directly buy and manage cryptocurrencies. It helps expand customer files and contribute to promoting the long-term development of the crypto market.
We hope this insight helps you gain a broader perspective and supports you in making informed investment decisions.
