Before investing in an ETF, investors must understand what makes up the fund. While it is easy to lump all ETFs into one category, the investment risks involved vary dramatically from fund to fund. ETF strategies continue to multiply, but there are three basic types of ETFs that investors should be able to identify: domestically-traded equity ETFs, international equity ETFs and futures/swap based ETFs.
Domestically-Traded Equity Based ETFs
These ETFs get a complexity rating of beginner. These ETFs, which trade on U.S. markets and track stocks that also trade on U.S. markets, are the most elemental of the group. These funds tend to closely track their underlying basket of stocks and trade close to net asset value (NAV). This group has lower risk because investments are easily hedgeable. A wide range of strategies are available with this type of fund, including commodity and international. The ETF itself is traded from 9:30 a.m. EDT to 4 p.m. EDT on a U.S. stock exchange. In addition, all components in the ETF's underlying basket are traded from 9:30 a.m. EDT to 4:00 p.m. EDT on a U.S. stock exchange. And finally, all components are stocks or ADRs. These ETFs use different strategies to expose investors to different sectors or themes. A passive indexing strategy will rank all the stocks in a certain category by capitalization or another stated combination of criteria, and allocate the fund's assets accordingly. Because some international companies use American Depository Receipts to trade on U.S. stock exchanges, internationally themed funds also appear in this category.