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ETFs: What They Are And How They Work

Exchange-traded funds (ETFs) are a unique, passive investment option that can help investors diversify their portfolios and maximize their returns. They offer the benefit of lower costs than mutual funds, as well as increased liquidity and tax advantages. In this article, we’ll discuss what ETFs are. Will will touch on how they work and why you should consider incorporating them into your investing strategy. 

What is an Exchange-Traded Fund? 

An exchange traded fund (ETF) is essentially a collection of stocks or bonds that acts like one large stock. They can be bought on public stock exchanges such as the Toronto Stock Exchange. The holdings in an ETF typically reflect some kind of benchmark index. Examples are the S&P TSX Index or the CVE / TSX Venture. They can also be tailored to track specific industrial sectors or geographic regions. 

Because ETFs trade publicly throughout the day just like regular stocks do at varying prices depending on supply and demand factors, they provide added flexibility for investors who want to switch between investments quickly while getting exposure to multiple securities.

But unlike actively managed mutual funds which require higher management fees due to buying/selling activities by portfolio managers, investors may look forward to relatively low operating costs with most ETFs. This is because underlying shares within these pool assets tend not to change significantly over time.

How Do Exchange Traded Funds Work?                                                  

When it comes to trading exchange-traded funds (ETF), it’s important that investors understand how these vehicles work before entering into any transaction. Here’s a brief overview:

Buying and Selling ETFs

When you buy an ETF from your broker, you’re actually purchasing shares of companies contained within that type of security once settlement has been finalized. However, when selling off such positions via market order execution, there is no guarantee related proceeds will equal opening cost basis per share given fluctuations in price movement leading up to the closing bell!   


As mentioned earlier, since all listed exchange traded products fluctuate in value based upon existing bid/ask market spreads during active hours, the same holds true whether being tracked globally.    

Why Should You Consider Incorporating ETFs Into Your Investment Strategy? 

As compared to the traditional open end mutual fund approach, ETFs allow for:

Lower Cost

ETFs typically have much lower expense ratios than actively managed funds. This means that investors pay less for the same exposure to a given market or sector. 

Tax Efficiency 

Because of their underlying index construction, ETFs tend to incur fewer capital gains taxes than mutual funds and other active investing strategies–potentially. This results in more wealth retention over time. 

Intraday Trading and Short Selling Capability

Unlike with traditional investments (mutual funds) which are priced at the end of trading day, ETF quotations can be accessed throughout normal market hours leading to greater flexibility when attempting specific investment strategies like short selling or momentum trading due to the fact that they trade just like stocks on a stock exchange.  

Greater Investment Diversity through Hedging Strategies 

Many ETFs utilize hedging strategies such as options or futures contracts allowing investors to diversify beyond long-term equity positions without having access to sophisticated derivative products directly from an approved broker/dealer account. This provides greater portfolio protection during uncertain economic times.