Everything You Need to Know About ETFs

By TradeSmith Editorial Staff

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You can find ETFs for almost any asset class, sector, investment strategy, niche, or trend you can think of.

Biotech? There’s an ETF for that. Cannabis? There’s an ETF for that. Social responsibility? There’s an ETF for that. Bonds? You get the idea.

These funds’ managers own baskets of different stocks and/or other assets to track the performance of an industry, currency, or, in some cases, entire national economies.

Investors buy these ETFs for income generation, appreciation, speculating, and even hedging against adverse events.

The sheer number of ETFs makes it impossible to go through them all, so we’ll just cover the biggest here to get you started.

And by that, I mean the index ETFs, those funds that track and replicate the performance of the lion’s share of the United States’ huge, bullish markets.

The Easy Way to Own the Entire Market

Index ETFs are a great place to start because U.S. equities are arguably the greatest wealth generators in human history. The U.S. stock market is by far the best-capitalized-on market on the planet, and it’s hailed as ultra-liquid and generally very safe. Although sell-offs and corrections always grab headlines, the trend for the past 100 years or more has been decidedly “up,” and you’ve got to be in it to win it. 

Around 3,500 stocks are trading at any one time, but most experts and, indeed, most regular investors focus on the shares found on the S&P 500, Dow Jones Industrial Average, Nasdaq 100, and, to a lesser degree, the small-caps of the Russell 2000.

  • The SPDR S&P 500 ETF Trust (SPY) tracks the performance of the S&P 500 but trades at about a tenth of the cost, with an expense ratio (total fees) of 0.95%.
  • The Dow Jones Industrial Average is tracked by the SPDR Dow Jones Industrial Average ETF Trust (DIA) for around one one-hundredth of the cost. Its expense ratio is 0.16%.
  • And the Invesco Nasdaq 100 ETF (QQQM), or “Q-mini,” tracks the 100 largest non-financial firms on the Nasdaq at a little less than half the price of the older Nasdaq ETF, the QQQ. It has a lower expense ratio, too, at 0.15%.

Those are the largest U.S. indexes, but I’d be remiss if I didn’t mention the small-caps. Small-cap stocks are a great way for investors to tap the power and dynamism of America’s startups and small companies. It’s like plugging into a big economic engine. The Russell 2000 tracks 2,000 of these powerhouse stocks, and theiShares Russell 2000 ETF(IWM) is the exchange-traded fund that tracks this index, with an expense ratio of 0.19%.

You Can Get Tactical with These ETFs

What goes up must come down, right? That’s true of stocks, too, and thanks to inverse ETFs, you can make money when the indexes fall. These will return the inverse of an index. If the S&P 500 falls 2%, its inverse ETF will gain 2%, for example.

It’s often called “going short,” but, to be clear, there’s absolutely no short-selling involved.

There are leveraged “ultra” and “ultra pro” inverse ETFs, too, which can return two and three times the inverse of the index in question. If the Dow falls 2% for the day, for instance, an ultra pro inverse ETF will rise 6% on that day.

That means, unlike the index ETFs, the inverse and leveraged-inverse ETFs are not—I repeat, not — long-term buy-and-hold propositions, especially in the middle of a historic bull market.

The smart move, then, is to use these ETFs tactically as a way to get in, make money, and get out when markets take a tumble. Many of these have options trades available, too, meaning you can trade them for even bigger profits at lower risk.

  • The ProShares Short S&P 500 ETF (SH) returns the inverse of the S&P 500.
  • The ProShares Short QQQ ETF (PSQ) will give you the inverse of the Nasdaq 100.
  • TheProShares Short Dow30 ETF (DOG) will hand out the inverse of the performance of the Dow Jones Industrial Average. 

I won’t get into the Ultra and Ultra Pro inverse ETFs here, but a quick Google search will bring up a wealth of actionable information. Depending on your acumen, creativity, and risk appetite, it’s possible to use inverse ETFs to profit on all kinds of geopolitical and economic events.

There’s one last group of key ETFs to talk about — they’ve got a creepy moniker, but they’ll treat you nicely…

Don’t Be Afraid of These Spiders

I’m talking about the SPDR ETFs, or “Sector Spiders,” as they’re called on Wall Street. It’s short for “Standard & Poor’s Depositary Receipts.” We got a look at those when we went over SPY a minute ago, but there’s much more to the SPDRs than that.

Standard & Poor’s slices and dices the entire S&P 500 into nice, neat sectors, each with its own ETF. Because they’re so concentrated, these ETFs can potentially carry higher risk than more diversified investments, so bear that in mind. On the other hand, the Spiders are extremely liquid, which means you shouldn’t have any trouble getting your buy or sell order filled at the price you’re looking for.

It’s also important to note that, because the S&P 500 is market-cap-weighted, specific sectors will have a bigger impact on the index than others. For example, the Technology sector accounts for 27.6% of the S&P 500 weighting, whereas the Energy sector accounts for just 2.3%. This is how it works when an index is weighted like the S&P 500.

The Spiders, in no particular order, are…

  • Communication Services Select Sector SPDR ETF (XLC): You can find companies likeAlphabet Inc.(GOOG) and AT&T Inc. (T) here.
  • Consumer Discretionary Select Sector SPDR ETF (XLY): Mighty Amazon.com Inc. (AMZN) and Tesla Inc. (TSLA) call this sector home, along with many others.
  • Consumer Staples Select Sector SPDR ETF (XLP): Tasty treats like Coca-Cola Co. (KO) andHershey Co. (HSY) can be found here along with grocery chains and cosmetics companies, to name a few.
  • Energy Select Sector SPDR ETF (XLE): Halliburton Co. (HAL) and Exxon Mobil Corp. (XOM) are here, and so are 19 other oil and gas companies.
  • Financials Select Sector SPDR ETF (XLF): Banks, insurance companies, brokers, credit card companies, and lots of others like Cincinnati Financial Corp. (CINF) and Charles Schwab Corp. (SCHW) live here.
  • Health Care Select Sector SPDR ETF (XLV): Biotech companies like Moderna Inc. (MRNA) and medical equipment companies like Henry Schein Inc. (HSIC) are in this sector, along with all kinds of health, life science, and pharma firms.
  • Industrials Select Sector SPDR ETF (XLI): Here’s where you’ll find stalwarts like Boeing Co. (BA) and Deere & Co. (DE), plus companies in logistics, defense, electronics, and the like.
  • Materials Select Sector SPDR ETF (XLB): Chemical companies like DuPont de Nemours Inc. (DD) and paper companies like Amcor plc (AMCR) live here, along with other companies in metals, construction, and other materials.
  • Real Estate Select Sector SPDR ETF (XLRE): Lots of big real estate investment trusts (REITs) like Vornado Realty Trust (VNO) and Regency Centers Corp. (REG) are found here.
  • Technology Select Sector SPDR ETF (XLK): Legacy blue chips like International Business Machines Corp. (IBM) and semiconductor companies like Qorvo Inc. (QRVO) fit into this sector, with lots of other headline names.
  • Utilities Select Sector SPDR ETF (XLU): Consolidated Edison Inc. (ED), Xcel Energy Inc.(XEL), and 26 other utilities are in this group.

With the Sector Spiders, you can use all kinds of investing strategies, like taking advantage of sector rotation, for instance, where capital “rotates” out of one sector and into another. If economic prospects look less-than-golden, you can cash in on the “flight to safety” phenomenon, where investors usually head for safe harbors like utilities. During the COVID-19 pandemic, health care and certain pharmaceutical companies have outperformed, and in the recovery period, real estate and industrials have picked up steam as the economy reflates.

These are just a few of the most well-known, useful ETFs out there.

Let’s dig into options trading on ETFs tomorrow.