A financial exchange-traded-fund (ETF) is an investment vehicle that tracks an index of financial stocks. Just as the Dow Jones Industrial Average or the S&P 500 tracks the broad market, so specific indexes track almost every sector of the stock market. In order to make these indexes investable, certain financial institutions have introduced ETFs.

Financial Indexes

Financial companies comprise one of the various sectors within the economy and the stock market. The sector can be broken down into more specialized industries, such as large banks, regional banks and brokerages. At the sector level, because many investors believe that stocks within the same sector will be affected by similar forces, sector indexes have been created. These indexes are made up of a sampling of financial stocks that are designed to give a fair representation of the sector. Some indexes will include a few stocks from each industry, while others will include more. These stocks are combined and indexed in order to give an ongoing picture of how financial companies are performing, both in absolute terms and relative to the rest of the market. Standard and Poor’s (S&P) and Russell are two of the most widely known index creators.

From Index to ETF

More and more, you are seeing ETFs being offered on any number of indexes. The financial sector, particularly given the volatility and uncertainty faced over the most recent few years, is no exception. An ETF is designed to track the performance of the underlying index. This is accomplished by the ETF company through a combination of positions, most commonly futures contracts. The futures markets have a long-standing history of making stock indexes investable. In some cases, however, the company may take positions in the individual constituents of the index in order to mirror the performance. In any case, you should know which financial index a particular ETF is tracking before investing to be sure it meets your investment criteria. Two common financial ETFs are XLF, offered by S&P, and PGF, offered by Powershares.

Exotic Financial ETF Options

In addition to straight sector financial ETFs, you can find more exotic choices as well. Leveraged ETFs that offer multiples of the performance of an index or its inverse are available. FAS and FAZ are two examples-–the first returns three times the performance of XLF, while FAZ returns three times the inverse of XLF. Double and triple long or short financials give you the opportunity to achieve a daily multiple of the performance of various financial indexes. Other financial ETFs will offer more specialized investment options. You can invest in only large, multi-national banks; you can limit yourself to brokerages; or you can focus on various regional options. All of these choices fall under the general heading of financial ETF. These instruments can provide you with focused investment opportunities that allow you to avoid the need to buy and track a large number of different companies affected by different forces. Essentially, financial ETFs are more targeted than broad market ETFs, but less so than specific financial stocks.

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