< Investing with Stocks: The Basics
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What are ETFs?

Think of exchange-traded funds (ETFs) as a basket of multiple stocks or other securities to let you invest in the broader market or a sector, industry, or even region. ETFs allow you to invest in a group of companies all at once.

When you invest in an ETF, the value of your investment will depend on how the collective group of companies is doing. You can buy or sell ETFs just as you would a stock.

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Why should I invest in ETFs?

Most investment experts will tell you it’s important to have a diverse portfolio of investments to help reduce risk in the market. ETFs are a great way to get instant diversification because instead of investing in a single company, by purchasing an ETF you’re investing in a basket of stocks for different companies, sectors or regions.

Diversification means investing in a variety of companies and sectors so that your portfolio’s performance is not tied to one company or industry sector risks. Keep in mind diversification does not ensure a profit or guarantee against a loss.

Example

If you believe cybersecurity is a smart investment, but don't know which single cybersecurity company to invest in, you may not have to pick one. Instead, a cybersecurity ETF could include shares from a variety of cybersecurity companies, giving you a wider range of investments in the cybersecurity industry.

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FAQs

What's a sector ETF?

A sector ETF is an investment vehicle that invests specifically in the stocks and securities of a particular industry or sector (a large grouping of companies with similar business activities). For example, a sector ETF may track a representative basket of stocks in the technology sector, or the healthcare sector.

What are an ETF’s holdings?

Holdings are the contents of the ETF, they may encompass a wide range of investment products including stocks, bonds, mutual funds, options, and futures. The number and types of holdings within an ETF contribute to its degree of diversification.

What are some common ETFs?

Some common ETFs include:

  • Broad index-based ETFs track popular indexes like the S&P 500 stock index, which is made up of 500 of the largest publicly traded US companies based on their value by market capitalization. Index ETFs can track various indices.
  • Sector or niche ETFs: track a more narrow part of the market such as a certain market segment, These types of ETFs can represent unique market segments like commodities (e.g., gold, oil), or they can specialize in a narrower segment of a larger class of assets (e.g., small companies, foreign companies, or cybersecurity companies). Investors in these ETFs are typically exposed to additional political, currency, and market risks.
  • Actively managed ETFs: are managed by a team of investment managers responsible for researching and making decisions about the ETF’s portfolio allocation.
Are ETFs the same as mutual funds?

Both contain the word “fund,” but they’re not exactly the same. Mutual funds and ETFs similarly can provide access or exposure to a wider range of investments in one, bundled, fund. Mutual funds also come in two primary types (open-ended and close-ended), which can each offer different characteristics. While ETFs and mutual funds both can provide investment diversification depending on what they are invested in and an investors’ circumstances, they differ in their structure, their benefits, and their risks.

Here are a couple of differences:

  1. An ETF is traded throughout the day on exchanges, like a stock. But mutual funds (like open-ended mutual funds) are only priced once daily, at the end of a trading day, and can only be redeemed after that price is determined daily once trading ends.

  2. ETFs are often designed to passively track a particular industry, index, or bundle of securities, so management fees can sometimes be lower (but fees will vary between ETFs).

What are the advantages of investing in ETFs?

ETFs provide a variety of benefits relative to other types of funds, such as mutual funds. Keep in mind that despite these advantages, all ETFs carry risk based on the underlying investments they hold.

  • “Intraday” trading: Just like a stock, ETF prices can move during the day and ETFs can be bought and sold during trading hours. For example, a day trader may buy an ETF in the morning, sell it at lunch, and re-buy it in the afternoon. An open-ended mutual fund, on the other hand, can only be redeemed once a day, after the market closes, at the fund’s end-of-day price.
  • Lower fees: Mutual funds may be actively managed by a fund manager, and in that case they typically charge higher fees for this service. But since ETFs often passively track the movements of an index or sector without as much active human direction, they typically don’t charge as much of a management fee. Some ETFs are actively managed however, and fees will vary between different ETFs and funds.
  • Diversification: The wide variety of ETFs available can make it easier to provide diversification to your portfolio. Different and increasingly niche ETFs specialize in certain sectors, areas, and securities that can help balance out your other investments.
What are the disadvantages of investing in ETFs?

Investing is serious, no matter the type of investment — stocks, commodities, mutual funds, or ETFs. In addition to an ETF’s benefits, there are also some disadvantages to keep in mind. Like any investment, ETFs carry risk, whether that’s the risk generally associated with investing in the financial markets, or or the specific risk of the companies in which it’s invested.

Here are some key disadvantages to keep in mind:

  • Variety: While ETFs may help diversify a portfolio, they aren’t necessarily diverse on their own. Some ETFs provide access to a wide variety of stocks within a specific region, sector, or topic, but not all do. Make sure you’re aware of exactly what the ETF in which you’re investing includes and whether that actually diversifies your portfolio, if that’s what you’re aiming for.
  • Market instability: Over the last decade, the growing popularity of ETFs has resulted in a surge of funds tracking various indices or industries. As a result, some research suggests that market volatility can be amplified because of the algorithm-driven investments by some of the funds.
  • Tradeability: ETFs can trade throughout the day like a stock, but that doesn’t mean they’re all necessarily easy to trade. Some ETFs that focus on more niche or obscure sectors may have relatively few buyers and sellers, making it harder to trade your ETF shares quickly at a price you want.
  • Leveraged, Inverse and Volatility ETFs: One could be structured to track the broader market, but it might be leveraged so that it rises 3x what the index did — remember though, that also means it falls by three times the amount when markets turn down. These risky, leveraged or inverse ETFs are generally used by short-term traders.
What is the difference between an actively and passively managed index fund?

Actively managed funds are managed by a team of investment managers responsible for researching and making decisions about the fund’’s portfolio allocation.

Passively managed funds aim to replicate a specific benchmark or index, in order to track that benchmark or index’s performance.

What is a 30-day yield?

The 30-day yield is based on a formula mandated by the Securities and Exchange Commission (SEC) that calculates a fund's hypothetical annualized income, as a percentage of its assets. It does not take into account the effect of changing share prices on the total return.

The 30-day yield is calculated by taking the fund's interest and/or dividend earnings for the most recent month and dividing by the average number of shares outstanding for the month times the highest share offer price on the last day of the month.

This hypothetical income will differ (at times, significantly) from the fund's actual experience; as a result, income distributions from the fund may be higher or lower than implied by the SEC yield.

What is an expense ratio on ETFs?

The expense ratio is the amount that an investment company charges investors to manage an investment portfolio, a mutual fund, or an exchange-traded fund (ETF). The ratio represents all of the management fees and operating costs of the fund.There are two types of expense ratios: Gross expense ratio and net expense ratio. The main difference between these two is that the gross expense ratio does not include any fee waiver or expense reimbursement agreements that may be in effect. These are fees charged by the fund provider, not by Robinhood.

What is the average annual return?

An annualized rate of return is calculated as the equivalent annual return an investor receives over a given period. The rate of return looks at gains or losses on investments over varying periods of time, while the annualized rate looks at the returns on a yearly basis including compounding and fees.

Why can I only see the top 10 holdings, where can I find all holdings in an ETFs?

Simply tap on the name of the ETF to get to it’s detail page where you will find a link to the company prospectus which will detail all of the fund’s holdings as of a specific date.

Disclosures:

Investors should consider the investment objectives and unique risk profile of any Exchange Traded Product (ETP), including any Exchange-Traded Fund (ETF) and any Exchange-Traded Notes (ETNs), carefully before investing. The prospectus and, if available, the summary prospectus contain this and other information about the ETP and should be read carefully before investing. For a current prospectus, customers should visit the relevant ETP’s details page to access a link to the prospectus.

ETPs that are designed to provide investment results that generally correspond to the performance of their respective underlying indices may not be able to exactly replicate the performance of the indices because of expenses and other factors. ETP shares are bought and sold at market price, which may be higher or lower than their NAV. ETPs are required to distribute portfolio gains to shareholders at year end. These gains may be generated by portfolio rebalancing or the need to meet diversification requirements. ETNs are subject to the credit risk of the underlying issuer. If the issuer defaults on the note, investors may lose some or all of their investment. ETP trading will also generate tax consequences. Additional regulatory guidance on Exchange Traded Products can be found at the SEC website and at the FINRA website (here and here).

Leveraged and inverse ETPs may involve greater risk and not be suitable for all investors, particularly for buy-and-hold investors. Volatility linked ETPs pose special risks tied to market volatility that can significantly impact the pricing of the product and your ability to trade them during times of extreme market volatility. These types of ETPs generally reset daily and are not designed to, and will not necessarily, track the underlying index or benchmark over a longer period of time. Investing in such ETPs may increase exposure to volatility through the use of leverage, short sales of securities, derivatives and other complex investment strategies.

All investments involve risks, including the loss of principal. Past performance is no guarantee of future results. This material is for informational purposes only, does not constitute tax or investment advice, and is not a recommendation of any security, transaction, account type, investment strategy involving securities, or order.

Securities trading offered through Robinhood Financial LLC, Member SIPC, a registered broker-dealer, and a subsidiary of Robinhood Markets, Inc.

Reference No. 20211029-1899430-5850015
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