Investment Education Course 02: What is a US Stock ETF?

What is a US Stock ETF? Introduction to US Stock ETFs

A US stock ETF (Exchange Traded Fund) is a fund traded on US stock exchanges. The characteristic of an ETF is that it can be bought and sold on the exchange, just like a stock.

In Chinese, many people also refer to ETFs as index stock funds because they securitize the performance of indices. However, some ETFs do not track specific indices but are actively managed by fund managers.

Unlike stocks, an ETF is like a portfolio that may contain numerous stocks, bonds, or other assets. Its purpose is to closely track the performance of a specific index or asset, allowing investors to easily track multiple market indices (not limited to the US), various commodities, and achieve diversified investments to spread risk.

The origin of US stock ETFs can be traced back to the early 1990s when State Street launched the first ETF in the US in 1993 to track the S&P 500 index. Since then, the ETF market has rapidly expanded and has become one of the most popular investment products globally.

Why Invest in US Stock ETFs?

Advantages of US Stock ETFs:

1. Diversified Investment: By including many different types of assets, investors can easily achieve portfolio diversification, reducing the risk and transaction costs associated with a single asset.
2. High Transparency: They provide good liquidity and transparency, making it easy to track asset price fluctuations.
3. Low Management Costs: ETFs are typically passively managed (tracking indices), avoiding the cumbersome processes of stock selection and rebalancing, saving time for investors.
4. Flexible Trading: With good liquidity, investors can buy and sell at any time during trading hours, quickly adjusting their portfolios based on market changes.

Disadvantages of US Stock ETFs:

1. Tracking Error: Although most ETFs attempt to accurately track indices, factors such as fees, liquidity, and reinvestment may cause the ETF's performance to differ slightly from its underlying index.
2. Specific Market Risks: Certain ETFs that specialize in specific industries or national markets (such as emerging market ETFs or tech stock ETFs) carry higher risks. Additionally, if systemic risks occur (such as a financial crisis or large-scale market adjustment), the prices of ETFs may still decline significantly.
3. Potential Underperformance Compared to Active Strategies: The performance of ETFs can only reflect the overall market average performance of the index, while actively selecting stocks may allow investors to pick individual stocks through various evaluation methods, timely adjust positions, and use leverage tools to achieve returns above the market average.

What Types of US Stock ETFs Are There? Categories of US Stock ETFs

There are many different types of US stock ETFs, each with its own advantages and disadvantages.

In addition to broad classifications based on market size or region, some US stock ETFs may focus more on specific industries or themes, such as technology, healthcare, energy, etc

Stock ETFs

Market Capitalization ETFs

U.S. companies can be categorized into large-cap, mid-cap, and small-cap based on their market capitalization.

• Large-Cap ETFs: These ETFs primarily invest in companies with large market capitalizations, typically over $10 billion. A representative example is the SPDR S&P 500 ETF Trust (SPY), which tracks the performance of the 500 largest publicly traded companies in the U.S. They are characterized by stability and lower risk, making them suitable for investors seeking steady returns.
• Mid-Cap ETFs: Mid-cap ETFs primarily invest in companies with market capitalizations between $2 billion and $10 billion. A representative index is the S&P MidCap 400 Index, with related ETFs like the iShares Core S&P Mid-Cap ETF (IJH), which tracks the performance of 400 medium-sized publicly traded companies in the U.S. Mid-cap ETFs are characterized by significant growth potential, with risk and returns falling between large and small companies.
• Small-Cap ETFs: Small-cap ETFs primarily invest in companies with market capitalizations below $2 billion. Representative indices include the S&P 600 Index and the Russell 2000 Index (which tracks the performance of the smallest 2,000 publicly traded companies in the U.S.), with related ETFs like the iShares Core S&P Small-Cap ETF (IJR) and the iShares Russell 2000 ETF (IWM). Small-cap ETFs are characterized by enormous growth potential, but they also carry relatively higher risks.

Regional ETFs

Regional ETFs select stocks and construct portfolios based on geographical regions, allowing investors to diversify their investments across different areas and reduce the risk of a single market. However, specific regional political and economic risks can be difficult to diversify, potentially having a significant impact on ETF performance, such as the effects of trade wars on China. The returns, volatility, and risks of different regional and sector ETFs can vary greatly. In addition to mainstream North America, there are several common regions:

• Asia ETFs: For example, the iShares MSCI All Country Asia ex Japan ETF (AAXJ) invests in stocks from emerging markets in Asia, including Greater China, India, and Southeast Asia, excluding Japan. The iShares Core MSCI Pacific ETF (IPAC) invests in Pacific countries including Japan, Australia, and Hong Kong, suitable for investors optimistic about Asian economic growth.
• Europe ETFs: For example, the Vanguard FTSE Europe ETF (VGK) and the iShares Core MSCI Europe ETF (IEUR) invest in stocks from developed countries in Europe, including the UK, France, and Germany, suitable for investors optimistic about European economic recovery
• Emerging Market ETFs: Such as Vanguard FTSE Emerging Markets Index Fund ETF Shares (VWO), iShares MSCI Emerging Markets ETF (EEM), and iShares Core MSCI Emerging Markets ETF (IEMG), which invest in global emerging markets including stocks from China, Taiwan, India, Brazil, etc. These have high growth potential but also higher risks, suitable for investors seeking high returns.

Single Country ETFs

Investing in U.S. stock ETFs can also diversify portfolios globally through different country-specific ETFs. For example:

• ETFs investing in the largest economy, the United States: Vanguard Total Stock Market Index Fund ETF Shares (VTI).
• ETFs tracking the important European market, the United Kingdom: iShares MSCI United Kingdom ETF (EWU).
• ETFs investing in Germany, a major industrial hub in Europe: iShares MSCI Germany ETF (EWG).
• ETFs investing in Japan, the third-largest economy globally: iShares MSCI Japan ETF (EWJ).
• ETFs tracking the Chinese market: iShares China Large-Cap ETF (FXI), known as the Chinese version of 0050.
• ETFs investing in rapidly developing emerging market countries: such as iShares India 50 ETF (INDY) for India, and iShares MSCI Brazil ETF (EWZ) for Brazil.
• ETFs tracking the MSCI Taiwan Index: iShares MSCI Taiwan ETF (EWT).

Industry ETFs

Industry ETFs typically invest in stocks of companies within a specific industry or sector, allowing investors to easily gain exposure to that industry's returns. Here are some common industry ETFs:

• Information Technology ETFs: Tracking the performance of tech companies like Apple, Microsoft, and Google, such as SPDR Technology Select Sector ETF (XLK).
• Energy ETFs: Tracking the performance of the energy sector, including oil, natural gas, and renewable energy companies, such as SPDR Energy Select Sector ETF (XLE).
• Financial ETFs: Tracking the performance of the financial services industry, including banks, insurance, and investment companies, such as SPDR Financial Select Sector ETF (XLF).
• Healthcare ETFs: Tracking the performance of the healthcare industry, including pharmaceuticals, biotechnology, and medical device companies, such as SPDR Health Care Select Sector ETF (XLV)
• Industrial ETFs: Track the performance of industrial companies such as Boeing, 3M, and General Electric, like the SPDR Industrial Select Sector ETF (XLI).
• Communication Services ETFs: Track the performance of companies that provide information as well as traditional telecom companies, like the SPDR Communication Services Select Sector ETF (XLC).
• Real Estate ETFs: Track the performance of Real Estate Investment Trusts (REITs) and real estate developers, like the SPDR Real Estate Select Sector ETF (XLRE).
• Utilities ETFs: Track the performance of utility companies such as electricity, water, and gas companies, like the SPDR Utilities Select Sector ETF (XLU).
• Consumer Staples ETFs: Track the performance of consumer product companies such as Costco, Coca-Cola, and Procter & Gamble, like the SPDR Consumer Staples Select Sector ETF (XLP).
• Consumer Discretionary ETFs: Track the performance of companies involved in automobiles, household durables, leisure, and apparel, like the SPDR Consumer Discretionary Select Sector ETF (XLY).
• Materials ETFs: Track companies related to manufacturing chemicals, materials, timber, and mineral products, like the SPDR Materials Select Sector ETF (XLB).

Choosing ETFs Based on Investment Style

Choosing ETFs based on investment style can be done according to the investor's risk tolerance and investment goals, such as growth-oriented or value-oriented. If the holdings do not particularly lean towards growth or value, they are classified as balanced.

Growth ETFs: Growth ETFs focus on investing in companies with high growth potential. These companies typically show gradual growth in revenue and invest heavily in business expansion and innovation. The investment goal of growth ETFs is to achieve capital appreciation through rising stock prices.

Examples: Vanguard Growth ETF (VUG), iShares Russell 1000 Growth ETF (IWF), Invesco QQQ Trust (QQQ).

Value ETFs: Value ETFs focus on investing in stocks of companies that are undervalued by the market. These companies typically have stable revenues and profits, with relatively low stock valuations (such as price-to-earnings ratios). The investment goal of value ETFs is to purchase undervalued stocks and wait for the market to reassess their value for capital appreciation.

Examples: Vanguard Value ETF (VTV), iShares Russell 1000 Value ETF (IWD), Schwab U.S. Large-Cap Value ETF (SCHV).

Income ETFs: Income ETFs include a portfolio of high-dividend or dividend-growing stocks, aiming to provide stable cash income and growth potential. These ETFs typically select companies with a stable dividend payment record, such as large, stable blue-chip stocks, but it is also important to note that dividend payments may vary with company performance Example: Vanguard Dividend Appreciation ETF (VIG), iShares Select Dividend ETF (DVY), SPDR S&P Dividend ETF (SDY), Schwab US Dividend Equity ETF (SCHD).

Choose ETFs Based on Investment Themes

Thematic ETFs have become a new trend in investing in U.S. stocks in recent years. These ETFs focus on specific investment themes, such as AI technology, electric vehicles, green energy, etc. By purchasing thematic ETFs, investors can concentrate on specific industries or trends they believe have growth potential, while also benefiting from the diversification characteristics of ETFs to reduce the investment risk of individual stocks. This investment approach not only offers the potential for high returns but also provides an opportunity to follow market trends and participate in innovative fields.

Bond ETFs

Bond ETFs are a type of ETF that invests in bonds, aiming to provide stable returns and relatively low risk. These ETFs typically track a bond index and invest in various types of government or corporate bonds. Here are some common bond ETFs:

• Global Market Bond ETFs: Vanguard Total World Bond ETF (BNDW), which includes U.S. Treasury bonds, corporate bonds, and non-U.S. bonds from regions such as the Eurozone, the UK, Japan, Canada, and Australia.
• U.S. Market Bond ETFs: Vanguard Total Bond Market ETF (BND), which tracks a broad index of the U.S. investment-grade bond market, including Treasury bonds, municipal bonds, and corporate bonds.
• U.S. Treasury Bond ETFs: iShares U.S. Treasury Bond ETF (GOVT), which tracks an index that includes U.S. Treasury bonds with various maturities, providing risk and return characteristics associated with U.S. Treasury bonds.
• Corporate Bond ETFs: iShares iBoxx Investment Grade Corporate Bond ETF (LQD), which tracks the U.S. investment-grade corporate bond index, covering bonds from various industries and credit ratings. iShares iBoxx Investment Grade Corporate Bond ETF (LQD), which tracks the U.S. investment-grade corporate bond index, covering bonds from various industries and credit ratings. iShares iBoxx High Yield Corporate Bond ETF (HYG), which tracks the U.S. high-yield corporate bond index, covering bonds with lower credit ratings, offering higher yields than investment-grade bonds but also carrying higher credit risk When choosing bond ETFs, investors should consider factors such as fees, tracking indices, credit ratings, and interest rate environments. They can also combine bond ETFs with other investment style ETFs to achieve a more comprehensive investment strategy.

Commodity ETFs

Commodity ETFs typically include a portfolio of metals, energy, agricultural products, and other commodities, effectively achieving diversification in investment portfolios. Compared to purchasing physical commodities, they are simple and convenient to operate. Commodity ETFs usually have value related to inflation, allowing investors to preserve value through investment in commodity ETFs, but they should also be aware that prices are influenced by market supply and demand and currency exchange rates, which carry significant volatility risks.

Examples: SPDR Gold Shares ETF (GLD) for investing in the gold market, United States Oil Fund (USO) for investing in the oil market, Invesco DB Agriculture ETF (DBA) for investing in the agricultural market.

REITs ETFs

Real Estate Investment Trusts (REITs) are investment tools that pool investors' funds to invest in real estate. They typically invest in properties with stable rental income, such as commercial, office, residential, shopping centers, and hotels, as well as power facilities and data centers, providing relatively stable cash returns. Compared to purchasing physical real estate, they are simple and convenient to operate; however, different REITs have varying risk and return characteristics, and it is important to note that REIT prices are influenced by the real estate market.

Examples: Vanguard Real Estate ETF (VNQ), iShares U.S. Real Estate ETF (IYR), Schwab U.S. REIT ETF (SCHH).

Currency ETFs

Currency ETFs are ETFs that invest in the foreign exchange market, aiming to track the performance of one or more currencies relative to another currency. These ETFs typically help investors gain returns from currency fluctuations, but they should also be aware of potential currency risks and global economic factors.

Examples: Invesco DB US Dollar Index Bullish Fund (UUP) tracking the U.S. dollar index, Invesco CurrencyShares Euro Trust (FXE) tracking the euro against the U.S. dollar, WisdomTree Emerging Currency Strategy Fund (CEW) tracking emerging market currencies against the U.S. dollar.

Leveraged ETFs

Leveraged ETFs aim to amplify the performance of underlying assets through leverage. Leveraged ETFs typically use derivative instruments such as futures contracts, options contracts, or swap contracts to achieve leveraged effects Typically, a leverage of 2x or 3x is applied to the underlying asset, meaning that if the price of the underlying asset increases by 1%, the price of the leveraged ETF may increase by 2% or 3%. Similarly, if the price decreases by -1%, the price of the leveraged ETF may decrease by -2% or -3%. This can amplify investors' returns but also magnifies risks, making it generally more suitable for investors with strong market views for short-term trading.

Examples: S&P 500 Index 2x performance ProShares Ultra S&P500 (SSO), Nasdaq 3x performance ProShares UltraPro QQQ (TQQQ), Financial Sector Index 3x performance Direxion Daily Financial Bull 3X Shares (FAS).

Inverse ETFs

Inverse ETFs are specifically designed to profit from declines in the underlying index or asset. These ETFs short the market using financial derivatives (such as futures and options), providing positive returns when the market declines. In other words, when the underlying index falls, the value of the inverse ETF rises; when the underlying index rises, the value of the inverse ETF falls. Inverse ETFs can serve as a hedging tool during market downturns; however, due to potential compounding effects between daily returns and the benchmark index, they are not suitable for long-term holding.

Examples: S&P 500 Index Inverse ProShares Short S&P500 (SH), Nasdaq Index Inverse 2x ProShares UltraShort QQQ (QID), Nasdaq Index Inverse 3x ProShares UltraPro Short QQQ (SQQQ).

Cryptocurrency ETFs

Cryptocurrency ETFs primarily invest in the cryptocurrency market, such as Bitcoin and Ethereum. These ETFs allow investors to gain exposure to the performance of the cryptocurrency market through a diversified portfolio without directly holding or managing these digital assets. Due to the relatively young nature of the cryptocurrency market and the uncertainty of the regulatory environment, cryptocurrency ETFs have not been widely approved in many countries and regions, while in the United States, it is more common to invest in companies related to the cryptocurrency industry.

Examples: Purpose Bitcoin ETF (BTCC) listed in Canada, VanEck Digital Transformation ETF (DAPP) tracking blockchain companies, ARK Next Generation Internet ETF (ARKW) This article is sourced from: finguider

The next article will introduce knowledge about dividends and taxes related to US stock ETFs, so stay tuned.

In the previous investment education course article 02, we introduced the two hottest ETFs in the current US stock market: "Investment Education Course 01: What are YINN and YANG?," if interested, you can click to see the details