Understanding ETFs – A Basic Guide

An exchange-traded fund (ETF) is a simple way to invest in a mix of stocks, bonds, and/or other assets with one purchase. Most ETFs are low cost and give you instant diversification, but some come with risks that can easily sink your profits. This guide breaks down 11 types of ETFs to help you decide which belong in your portfolio.

11 Types of ETFs Worth Knowing About

ETFs come in many forms, each designed for a different goal or market. Here’s a breakdown of the main types you’ll see most often and what they’re best suited for:

1. Broad market ETFs (index ETFs)

Broad market ETFs track major stock indexes such as the S&P 500, the total U.S. stock market, or global indexes. These funds simply match the performance of the market; if the S&P 500 rises 10%, your ETF should rise about the same amount, minus a tiny annual fee. Because there’s no active management, costs are typically very low, often under 0.10% per year.

These ETFs are popular because they’re simple, affordable, and effective.  By buying a single fund, you gain exposure to hundreds or even thousands of companies without needing to research individual stocks. For many people, they’re the core of a strong long-term portfolio, which is why most of my own investments sit in broad market index funds.

These ETFs are best for:

• Long-term investors who want a hands-off approach to own a diversified portfolio
• Anyone building retirement savings
• Beginners who want low-cost exposure to the overall market

2. Industry-specific ETFs (sector ETFs)

Industry-specific ETFs focus on one area of the economy, such as technology, healthcare, energy, or financial services. Instead of guessing which single company will perform best, you can invest in the entire sector at once. A tech ETF, for example, might hold Apple, Microsoft, and dozens of smaller firms, giving you broad exposure without the risk associated with picking individual winners.

These funds are useful when you believe a specific industry will grow faster than the overall market. They let you invest in trends you understand or feel confident about, while still keeping your risk spread across multiple companies. Compared to choosing single stocks, sector ETFs make it easier to lean into industries you expect to outperform without betting everything on one business.

These ETFs are best for:

• Investors who want exposure to specific industries without picking individual stocks
• People who want to emphasize certain sectors in their portfolio beyond what broad market ETFs provide
• Anyone who understands an industry well and wants diversified access to it

3. Bond ETFs

Bond ETFs invest in fixed-income securities, which are essentially loans to governments, corporations, or districts that pay you interest over time. These funds can include U.S. Treasury bonds, corporate bonds, municipal bonds, or international debt. Because bonds tend to move differently from stocks, bond ETFs help stabilize a portfolio when the stock market becomes uncertain; when stocks fall, bonds often hold their value or even rise, providing a cushion during rough times.

For many investors, bond ETFs act as the steady counterbalance to riskier stock holdings. They don’t offer explosive growth, but they provide consistency, income, and a smoother ride overall. Most funds pay out regular interest, which can be reinvested or used as cash flow. Even a small allocation to bond ETFs can make a portfolio less volatile and easier to stick with through market ups and downs.

These ETFs are best for:

• Investors who want to lower overall portfolio risk with more stable assets
• People nearing retirement who prefer predictable income and less volatility
• Anyone building a balanced portfolio that includes both stocks and bonds

4. Dividend ETFs

Dividend ETFs focus on companies that share their profits with investors through regular cash payments called dividends. These funds typically include well-established businesses with steady earnings and strong track records of rewarding shareholders. Some dividend ETFs chase high yields, while others prioritize consistency and include companies that have raised dividends for decades.

Investing in dividend ETFs can add a reliable stream of income to your portfolio without forcing you to sell shares when you need cash. They’re especially appealing during times of market uncertainty, since dividend-paying companies are usually more financially stable than those that reinvest all their profits. Over time, reinvesting those dividends can also accelerate your portfolio’s growth, creating a compounding effect that steadily builds wealth.

These ETFs are best for:

• Investors who want consistent income without selling their holdings
• Retirees or near-retirees who need dependable cash flow
• Anyone looking to invest in profitable, established companies that return value to shareholders

5. Commodity ETFs

Commodity ETFs give you a way to invest in physical goods like gold, silver, oil, natural gas, or agricultural products. Instead of storing physical commodities, most of these funds use futures contracts or invest in companies tied to those markets. Some funds stick to a single commodity, while others diversify across several to balance risk.

Investors often turn to commodity ETFs to hedge against inflation or market volatility. When prices rise and the dollar weakens, commodities tend to hold their value or even climb higher. Since they behave differently from stocks and bonds, they can help diversify your portfolio. However, commodity prices can swing sharply based on global supply and demand, so these ETFs work best as a small slice of a broader portfolio.

These ETFs are best for:

• Investors who want diversification beyond traditional stocks and bonds
• People looking to hedge against inflation and rising prices
• Anyone interested in gaining exposure to commodities without handling physical assets

6. Real estate ETFs (REIT ETFs)

Real estate ETFs invest primarily in real estate investment trusts, or REITs, which are companies that own and manage income-producing properties like apartment buildings, shopping centers, warehouses, and office spaces. With a real estate ETF, you can invest in property markets without being a landlord. Some funds focus on specific areas, like commercial or residential properties, while others hold a mix of different property types across various regions.

REITs are legally required to distribute most of their profits to shareholders as dividends, which means real estate ETFs often provide consistent income in addition to potential price gains. Because real estate doesn’t always move in sync with the stock market, these funds can also add diversification and help smooth out portfolio performance over time.

These ETFs are best for:

• Investors who want real estate exposure without buying property directly
• People looking to diversify beyond stocks and bonds
• Anyone interested in earning regular dividend income from real estate investments

7. Actively managed ETFs

Actively managed ETFs have professional managers who decide what to buy and sell. Unlike index funds that simply track a benchmark, active managers try to outperform the market using research and timing. The goal is to earn higher returns than the market average, though success depends on the manager’s skill and the strategy they follow. Because these funds require more hands-on management, they generally have higher fees, often between 0.50% and 1.00% annually.

The main advantage of actively managed ETFs is flexibility; managers can react quickly to market changes or take advantage of new opportunities that an index fund would ignore. At the same time, that flexibility comes with added risk, since not every manager consistently beats the market after fees are factored in.

These ETFs are best for:

• Investors who believe professional managers can outperform the market
• People comfortable paying higher fees for potential outperformance
• Anyone who wants active management combined with ETF trading flexibility

8. Currency ETFs

Currency ETFs let you invest in foreign currencies without directly trading on the forex market. These funds track the value of one or more currencies against the U.S. dollar, such as the euro, Japanese yen, or British pound. Some focus on a single currency, while others hold a mix to reflect broader global trends. When a foreign currency strengthens relative to the dollar, the ETF’s value rises; when it weakens, the ETF falls.

While currency ETFs can add global diversification, they’re usually better suited for experienced investors. Currency values shift based on interest rates, inflation, and international economic conditions, which can make them unpredictable. Still, they can serve a purpose for those who want to hedge against currency risk from overseas investments or take advantage of exchange rate movements. For most casual investors, though, they’re more of a specialized tool than a portfolio staple.

These ETFs are best for:

• Investors with experience in foreign exchange markets
• People hedging international investments or business exposure
• Sophisticated investors using specific currency strategies

9. Leveraged ETFs

Leveraged ETFs use borrowed money and financial derivatives to amplify the daily returns of an index. A 2x leveraged ETF, for example, aims to deliver twice the daily performance of its benchmark. But while gains are doubled, the same works in reverse, meaning losses are also doubled when the market falls. Because these funds reset daily, holding them long term can lead to unpredictable results.

These funds are built for short-term traders who closely monitor the market, not long-term investing; although they can be profitable for quick moves, the risks are high. Over time, the effects of compounding and daily rebalancing can create unpredictable results if you hold them too long. Leveraged ETFs can be profitable when used correctly, but they demand experience, discipline, and constant attention.

These ETFs are best for:

• Experienced traders looking for short-term exposure
• Investors who understand leverage and daily compounding effects
• Professionals with high risk tolerance who actively manage their positions

10. Inverse ETFs

Inverse ETFs are designed to move in the opposite direction of the market or index they track: If the S&P 500 drops 1%, an inverse S&P 500 ETF should rise about 1%. These funds use derivatives to profit from market declines rather than gains; like leveraged ETFs, inverse ETFs reset daily, which makes them risky to hold for long periods.

These ETFs can be useful tools for traders who want to hedge other positions or take short-term bearish bets without using margin accounts. However, they’re not ideal for beginners or long-term investors. If the market moves against you, losses can pile up quickly. Most investors are better off avoiding them unless they fully understand how daily resets and volatility affect returns.

These ETFs are best for:

• Sophisticated investors who want to profit from market declines
• Traders making short-term bearish moves
• Professionals using inverse ETFs to hedge other holdings

11. Crypto ETFs

Crypto ETFs make it easier to invest in digital assets, like Bitcoin or Ethereum, through regular brokerage accounts. Instead of setting up crypto wallets or dealing with exchanges, you can buy shares in a fund that holds the cryptocurrency directly or tracks its price through futures contracts. Some of these ETFs also use strategies like covered calls or leverage to adjust returns or manage risk.

Crypto ETFs bring convenience to an otherwise complex space, but they still carry the volatility of the crypto market. They can work for investors who want crypto exposure without handling the assets themselves, as long as they keep it as a small, speculative part of their portfolio.

These ETFs are best for:

• Investors who want crypto exposure through a standard brokerage account
• People comfortable with high volatility and potential large price swings

How to Start Investing in ETFs

If you’re ready to begin, you have three main options for buying ETFs. The process is similar across platforms, but cost and support vary depending on how involved you want your broker to be.

Buy ETFs through online brokers

Online brokers such as Vanguard, Fidelity, Charles Schwab, and TD Ameritrade make it easy to buy and sell ETFs on your own schedule. You open an account, move money from your bank, search for the ETF you want, and place your order at the current market price.

Most large brokers now offer commission-free ETF trading, which helps you keep more of your returns. Many also offer their own low-cost ETF lines, giving you an affordable place to start. Vanguard ETFs, for example, trade without commissions on Vanguard’s platform, and Fidelity gives you access to a wide range of commission-free iShares ETFs.

Opening an online brokerage account

If you have never opened an account before, the process is straightforward:

1. Go to the broker's website and select the option to open a new account.
2. Choose an individual brokerage account or an IRA if you want tax benefits.
3. Enter your personal information, including your Social Security number and basic employment details.
4. Link your bank account so you can transfer funds in and out.
5. Make an initial deposit if the broker requires one.
6. Wait for the account to be verified, which typically takes three to seven days.
7. Once approved, search for the ETF by its ticker symbol and place your order.

Buy ETFs through traditional broker-dealers

Traditional broker-dealers offer more personal service and guidance because you’ll work directly with a financial advisor who can recommend specific ETFs and place trades for you. This approach is more expensive, since you’ll pay commissions or advisory fees, but it can be worth it if you prefer expert input or don’t want to manage your investments on your own. The trade-off is cost versus convenience: Do-it-yourself investing is cheaper, but full-service brokers save you time and uncertainty.

Add ETFs to your retirement accounts

You can also invest in ETFs through retirement accounts such as 401(k)s or IRAs. Many 401(k) plans now include ETF options alongside mutual funds, and IRAs give you complete control to choose the funds you want. The buying process is nearly identical to that of a regular brokerage account, but the tax advantages differ. 

Traditional accounts may allow tax-deductible contributions, while Roth accounts offer tax-free withdrawals in retirement. Just remember that retirement accounts have annual contribution limits and penalties for early withdrawals, so keep short-term money in regular brokerage accounts instead.

Should You Invest in ETFs? Consider Both Sides

ETFs can be a powerful tool for building wealth, but like any investment, they come with pros and cons. Understanding both sides helps you make better decisions before committing your money.

Pros

Here are some of the benefits of investing in ETFs:

1. Instant diversification with one purchase

Buying a single ETF gives you exposure to dozens or even thousands of investments. For example, an S&P 500 ETF covers 500 major U.S. companies, while a total market ETF might include over 3,000. This built-in diversification spreads your risk and keeps your portfolio from depending too heavily on any one stock.

2. Extremely low fees compared to mutual funds

Most index ETFs charge less than 0.10% per year in expenses, and sometimes as little as 0.03 percent. That means you could pay just a few dollars annually for every $10,000 invested. On the other hand, actively managed mutual funds often charge around 1% or more. Over time, those cost differences compound into substantial savings instead of going back to fund managers.

3. Flexibility to trade anytime during market hours

ETFs trade throughout the day just like stocks; you can buy or sell whenever the market is open, giving you control over timing and price. Mutual funds only settle once per day, after the market closes, which can make trading less precise. This flexibility matters if you need access to your money or want to take advantage of market movements.

Cons

These factors might be worth thinking about before you invest:

1. Trading costs can add up

While many brokers now offer commission-free trading, not all ETFs qualify. Even small fees can eat into returns if you’re investing small amounts frequently; investing $500 monthly with a $10 commission fee, for example, means you’re losing 2% to fees right off the bat. The best fix is to invest larger sums less often or use commission-free ETFs from your broker’s platform.

2. Low-volume ETFs can be hard to trade

Some niche or specialized ETFs have limited trading activity, which can make it difficult to buy or sell at a fair price. Low liquidity can cause you to pay more than the ETF’s actual value or wait longer for a buyer. Stick with popular, high-volume ETFs that trade millions of shares daily to avoid this problem.

3. Easy trading can tempt you to overtrade

Because ETFs are so easy to buy and sell, it’s tempting to trade often in response to market swings; however, frequent trading increases costs and taxes and usually hurts returns. If over 90% of professional traders can’t successfully time the market, you probably can’t either, so long-term holding is generally the smarter move.

Living Your Rich Life Through Smart Investing

Every investment decision should start with understanding what you’re buying and why. ETFs can be an excellent way to grow wealth, but they still carry risks like any other investment. Before buying, review the fund’s strategy, fees, and holdings to make sure they align with your goals. Avoid putting in money you’ll need soon, and resist chasing hype or trends you don’t fully understand.

Smart investing is about consistency and clarity. The goal isn’t to find the perfect trade; it’s to build a portfolio that supports your version of a Rich Life built on steady growth, informed choices, and financial peace of mind.