Types of ETFs

The modern ETF market offers diverse strategies, ranging from simple passive indices to complex derivative-based structures:

Passively Managed Index ETFs

These track a benchmark index such as the S&P 500 or the Nasdaq-100. They offer broad market exposure, minimal tracking error, high liquidity, and optimal tax-efficiency. Examples include Vanguard S&P 500 ETF VOO(.03%), iShares Core S&P 500 ETF IVV(.03%), SPDR Portfolio S&P 500 ETF SPLG(.02%), and Invesco NASDAQ 100 ETF QQQM(.15%).

Actively Managed ETFs

These employ portfolio managers to actively select holdings with the objective of outperforming a benchmark. They demand higher expense ratios and carry active manager risk, with no structural guarantee of outperformance. Examples include ARK Innovation ETF ARKK(.75%) and JPMorgan Income ETF JPIE(.40%).

Leveraged ETFs

These employ debt and derivatives (swaps, futures) to amplify the daily returns of an index, typically by 2x or 3x (e.g., ProShares UltraPro QQQ TQQQ(.98%), ProShares Ultra QQQ QLD(.95%)). Because the leverage resets daily, volatile sideways markets cause severe compounding decay.

Let the daily return of the index be $R_i$. For a $k$-times leveraged ETF, the daily return is $k{R}_i$. Over $n$ days, the index return is ${\prod <!--\; FUNCTION\; APPLICATION\; -->}_{i=1}^n(1+R_i)-1$, whereas the leveraged ETF return is ${\prod <!--\; FUNCTION\; APPLICATION\; -->}_{i=1}^n(1+k{R}_i)-1$. If the index is highly volatile with zero net return, the leveraged ETF will decay due to the variance drag. For example, if the index alternates daily between $+10\%$ and $-9.09\%$ (returning to its exact starting point), a 3x leveraged ETF oscillates between $+30\%$ and $-27.27\%$. Over one full two-day cycle, the leveraged ETF suffers a net loss of 5.45%:

$$(1+0.30)(1-0.2727)-1=-0.0545$$

(12.3)

This variance drag makes leveraged ETFs entirely unsuitable for long-term holding.

BuyWrite ETFs (Covered Call)

These funds, such as JPMorgan Equity Premium Income ETF (JEPI) or Global X Nasdaq 100 Covered Call (QYLD), hold an underlying equity portfolio and write (sell) short-term call options, collecting the buyers’ premiums as income. While appealing to yield-seeking investors, this structure has substantial drawbacks. The written call options cap upside potential during bull markets while leaving the portfolio fully exposed to downside market shocks. Furthermore, option premiums are distributed as ordinary income, creating a heavy tax liability for high-income earners compared to long-term capital gains or qualified dividends. The covered-call mechanics these funds run at scale, and their tax treatment, are detailed in section “Covered Call Strategy” and section “Taxation of Equity Options”. For a detailed screener, refer to ETFdb’s BuyWrite ETF Directory.

Inverse ETFs

These deliver the negative multiple of an index’s daily performance (e.g., ProShares SPXU UltraPro Short S&P500 SPXU(.90%), ProShares Short QQQ PSQ(.99%)). Like leveraged ETFs, their daily reset structure makes them unsuitable for long-term hedging due to rapid volatility decay.

Growth and Sector ETFs

These provide targeted exposure to high-growth styles (e.g., Vanguard Growth ETF VUG(.04%), Schwab U.S. Large-Cap Growth ETF SCHG(.04%)) or specific industry groups (e.g., The Technology Select Sector SPDR Fund XLK(.09%) for technology, The Financial Select Sector SPDR Fund XLF(.09%) for financials). While useful for tactical tilts, they increase portfolio concentration risk.

Bond ETFs

These hold portfolios of fixed-income instruments (e.g., Vanguard Total Bond Market ETF BND(.03%), iShares Core U.S. Aggregate Bond ETF AGG(.03%)). Unlike holding individual bonds to maturity, bond ETFs have no fixed maturity date and maintain a constant duration, making their market prices permanently sensitive to interest rate fluctuations.

Cash Alternative ETFs

These invest in ultra-short Treasury bills (e.g., SPDR Bloomberg 1-3 Month T-Bill ETF BIL(.14%), iShares 0-3 Month Treasury Bond ETF SGOV(.09%)). In a high-tax state (CA, NY) these are highly efficient, because interest on U.S. Treasury obligations is exempt from state and local income tax — a statutory exemption under 31 U.S.C. § 3124(a), resting on the intergovernmental tax immunity doctrine, not any clause of the Constitution itself. Check the passthrough at the fund level before relying on it: several states, California among them, exempt a fund’s distribution only if the fund held at least 50% U.S. government obligations at the close of each quarter ( Cal. R&TC § 17145). Near-pure bill funds like these clear that bar comfortably; broader “government” funds holding agency paper and repo often do not.

Cryptocurrency ETFs

These provide spot or futures-based exposure to digital assets like Bitcoin and Ethereum (e.g., iShares Bitcoin Trust ETF IBIT(.25%), iShares Ethereum Trust ETF ETHA(.25%)). They eliminate self-custody and brokerage barriers but introduce institutional fees onto highly volatile assets. The tax treatment is not what the wrapper suggests: these are grantor trusts, so you are treated as owning the underlying coin directly, and the trust’s monthly sales to pay expenses are taxable dispositions by you — the same mechanic as the metal trusts in section “Collectible Tax Rates”. Digital assets are not collectibles, so the 28% rate does not apply, but see section “Cryptocurrency and Digital Assets” before assuming an ETF wrapper simplifies anything.