Exchange-Traded Funds For Dummies Cheat Sheet (2024)

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By: Russell Wild and

Updated: 10-01-2021

From The Book: Exchange-Traded Funds For Dummies

Exchange-Traded Funds For Dummies

Exchange-Traded Funds For Dummies Cheat Sheet (1)

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An exchange-traded fund (ETF) is something of a cross between an index mutual fund and a stock. It’s like a mutual fund but has some key differences you’ll want to be sure you understand. Here, you discover how to get some ETFs into your portfolio, how to choose smart ETFs, and how ETFs differ from mutual funds.

Asking a financial professional about working ETFs into your portfolio

If you’re willing to spend time reading quality resources about exchange-traded funds and portfolio construction, you can create for yourself a portfolio that balances risk and potential return and aims toward your investment goals.

However, many people find that they want at least a bit of guidance from a financial pro before making investment decisions. If that describes you, look for a fee-only financial planner (someone who does not earn commissions on your investments). Here are some questions to ask when you meet that person:

  • Given my personal economics, how much risk should I be taking with my money? Specifically, what percent of my portfolio should be in stock ETFs and what percent in bond ETFs?
  • Given the size of my portfolio, how many individual ETFs would you suggest?
  • Which brokerage house do you recommend for housing my ETF portfolio?
  • What is the historical rate of return on the ETF portfolio that you are suggesting, and just how volatile can it be?
  • Given my age, my tax bracket, and my employment, what kind of account — IRA, Roth IRA, or taxable brokerage account — do you suggest for my ETFs?
  • What selection of ETFs would you advise for an optimally diversified portfolio?
  • Do I keep my present investments, or sell them? If I keep them, how are you going to choose ETFs that best complement those investments?
  • Can you help me juggle the investments in my 401(k) plan to complement my new ETF portfolio?

Choosing the best ETFs

With about 1,300 exchange-traded funds available, where do you start to shop? The answer depends on your objective. If you are looking to round out an existing portfolio of stocks or mutual funds, your ETFs should complement your existing investments. Your goal is always to have a well-diversified collection of investments.

If you are starting to build a portfolio, you want to make sure to include stocks and bonds and to diversify within those two broad asset classes.

There is not much in the world of stocks, bonds, and commodities that can’t be satisfied with ETFs. Keep the following guidelines in mind as you make selections:

  • Mix and match your holdings appropriately.
    You not only want a well-diversified portfolio, but one that includes various asset classes that tend to go up and down in value at different times. There’s no point to holding four different ETFs that all invest in large-cap stocks. Hold a large-cap ETF anda small-cap, a U.S. stock ETF and an international stock ETF.
  • Go for lowest cost.
    As with any other investment vehicle, be careful not to pay more than you need to. Although most ETFs are very economical, some are more economical than others. You may not always want to pick the cheapest, but certainly aim in that direction.
  • Don’t sweat the small stuff.
    Two ETFs that track similar indexes (such as large value stocks, for example) are not going to be all that different from one another. Spend some time researching your options, but don’t agonize over your selection. Much more important — perhaps worth a littleagony — is choosing ETFs that track dissimilar indexes so your eggs are in different baskets.
  • Go passive.
    A handful of ETFs promise “active management.” Know that active management has an awfully spotty track record. The bulk, if not all, of your ETF portfolio should be in passively managed (indexed) ETFs.
  • Look for breadth.
    Examine the holdings of the ETF. As a rule, no one security (such as, for example, Microsoft or General Electric stock) should represent more than 10 percent of the ETF’s total assets.

How ETFs differ from mutual funds

At first glance, an exchange-traded fund (ETF) may seem awfully similar to a mutual fund. After all, like ETFs, mutual funds also represent baskets of stocks or bonds. The two, however, are certainly not twins. Maybe not even siblings. Cousins are more like it. Here are some of the significant differences between ETFs and mutual funds:

  • ETFs are bought and sold just like stocks (through a brokerage house, either by phone or online), and their price can change from second to second. Mutual fund orders can be made during the day, but the actual trade doesn’t occur until after the markets close.

  • ETFs tend to represent indexes — entire markets or market segments — and the managers of the ETFs tend to do very little trading of securities in the ETF. (The ETFs are passively managed.)

  • Although they require you to pay small trading fees, ETFs usually wind up costing you much less than a mutual fund because the ongoing management fees are typically much less, and there is never a load (an entrance or exit fee, sometimes an exorbitant one) as there is with some mutual funds.

  • Because of low portfolio turnover and also the way they are structured, investment gains on ETFs usually are taxed more gingerly than the gains on mutual funds.

The following table provides a quick look at some ways that investing in ETFs differs from investing in mutual funds.

ETFsMutual Funds
Priced, bought, and sold throughout the day?YesNo
Offer some investment diversification?YesYes
Is there a minimum investment?NoYes
Purchased through a broker or online brokerage?YesYes
Do you pay a fee or commission to make a trade?OftenVery rarely
Can you buy/sell
Indexed (passively managed)?TypicallyAtypically
Can you make money or lose money?YesYes

About This Article

This article is from the book:

  • Exchange-Traded Funds For Dummies ,

About the book author:

Russell Wild, MBA, an expert on index investing, is a fee-only financial planner and investment advisor and the principal of Global Portfolios. He is the author or coauthor of nearly two dozen nonfiction books.

This article can be found in the category:

  • Funds ,
  • Choosing the Best ETFs
  • How ETFs Differ from Mutual Funds
  • Websites for Up-to-Date ETF Information
  • Asking a Financial Professional about Working ETFs into Your Portfolio
  • Exchange Traded Funds: Systemic and Nonsystemic Risk
  • View All Articles From Book
Exchange-Traded Funds For Dummies Cheat Sheet (2024)


How does an ETF work for dummies? ›

"ETFs are similar to mutual funds in that they hold a collection of stocks and bonds in a single fund," writes Kiplinger contributor Will Ashworth in his feature "How to Invest in ETFs for Beginners." However, unlike mutual funds, ETFs "are bought and sold on stock exchanges, can be traded anytime the exchange is open, ...

How do I choose an ETF for beginners? ›

Before purchasing an ETF there are five factors to take into account 1) performance of the ETF 2) the underlying index of the ETF 3) the ETF's structure 4) when and how to trade the ETF and 5) the total cost of the ETF.

What is an exchange-traded fund in layman's terms? ›

ETFs or "exchange-traded funds" are exactly as the name implies: funds that trade on exchanges, generally tracking a specific index. When you invest in an ETF, you get a bundle of assets you can buy and sell during market hours—potentially lowering your risk and exposure, while helping to diversify your portfolio.

Do you pay taxes on ETF if you don't sell? ›

At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.

How many ETFs should I own as a beginner? ›

Experts agree that for most personal investors, a portfolio comprising 5 to 10 ETFs is perfect in terms of diversification.

How do you actually make money from ETFs? ›

How do ETFs make money for investors?
  1. Interest distributions if the ETF invests in bonds.
  2. Dividend. + read full definition distributions if the ETF invests in stocks that pay dividends.
  3. Capital gains distributions if the ETF sells an investment. + read full definition for more than it paid.
Sep 25, 2023

What are the top 5 ETFs to buy? ›

7 Best ETFs to Buy Now
ETFAssets Under ManagementExpense Ratio
Vanguard Information Technology ETF (VGT)$70 billion0.10%
VanEck Semiconductor ETF (SMH)$16.3 billion0.35%
Invesco S&P MidCap Momentum ETF (XMMO)$1.6 billion0.34%
SPDR S&P Homebuilders ETF (XHB)$1.8 billion0.35%
3 more rows
Apr 3, 2024

How much money should I put in one ETF? ›

You expose your portfolio to much higher risk with sector ETFs, so you should use them sparingly, but investing 5% to 10% of your total portfolio assets may be appropriate. If you want to be highly conservative, don't use these at all.

What do you actually own when you buy an ETF? ›

There is no transfer of ownership because investors buy a share of the fund, which owns the shares of the underlying companies. Unlike mutual funds, ETF share prices are determined throughout the day. A mutual fund trades only once a day after market close.

What is the difference between an ETF and an exchange traded fund? ›

ETFs, the most common type of ETP, are pooled investment opportunities that typically include baskets of stocks, bonds and other assets grouped based on specified fund objectives. Unlike ETFs, ETNs don't hold assets—they're debt securities issued by a bank or other financial institution, similar to corporate bonds.

What is a key benefit of an exchange traded fund? ›

ETFs have several advantages for investors considering this vehicle. The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs versus like mutual funds, and potential tax benefits.

Is it safe to invest in exchange-traded funds? ›

ETFs can be safe investments if used correctly, offering diversification and flexibility. Indexed ETFs, tracking specific indexes like the S&P 500, are generally safe and tend to gain value over time. Leveraged ETFs can be used to amplify returns, but they can be riskier due to increased volatility.

What is the 30 day rule on ETFs? ›

Q: How does the wash sale rule work? If you sell a security at a loss and buy the same or a substantially identical security within 30 calendar days before or after the sale, you won't be able to take a loss for that security on your current-year tax return.

What is the downside of ETFs? ›

For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.

How long should you hold an ETF? ›

For most ETFs, selling after less than a year is taxed as a short-term capital gain. ETFs held for longer than a year are taxed as long-term gains. If you sell an ETF, and buy the same (or a substantially similar) ETF after less than 30 days, you may be subject to the wash sale rule.

What is the downside of owning an ETF? ›

ETFs are subject to market fluctuation and the risks of their underlying investments. ETFs are subject to management fees and other expenses. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than their NAV, and are not individually redeemed from the fund.

Are ETFs good for beginners? ›

The low investment threshold for most ETFs makes it easy for a beginner to implement a basic asset allocation strategy that matches their investment time horizon and risk tolerance. For example, young investors might be 100% invested in equity ETFs when they are in their 20s.

Is it easy to take money out of ETF? ›

Key Takeaways

Introduced in the U.S. in 1993, ETFs have become one of the most popular investment choices for investors. ETFs may close due to lack of investor interest or poor returns. For investors, the easiest way to exit an ETF investment is to sell it on the open market.

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