Exchange Traded Funds (ETF's)


 

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Exchange-Traded Funds, or ETF's, are index funds that trade just like stocks on the major stock exchanges.  Each share of an ETF represents a basket of stocks, designed to track a specific market index or sector.  And they're designed to match the performance of that index.  All the major indexes now have ETF's based on them, including the Dow Jones Industrial Average, S&P 500 and the Nasdaq Composite.  And since the year 2000, the number of ETF's has grown into the hundreds.  Pick a market index or asset class, and there is a good chance it's represented by an ETF, or will be soon.  Some of the more popular categories which ETF's represent are:
  • Major Market Indexes
  • Large Cap Stocks
  • Mid Cap Stocks
  • Small Cap Stocks
  • Micro Cap Stocks
  • Growth Stocks
  • Value Stocks
  • Dividend Stocks
  • Sector Stocks
  • International Stocks
  • Country
  • Emerging Market Stocks
  • Long-term Bonds
  • Mid-term Bonds
  • Short-term Bonds
  • Real Estate Investment Trusts
  • Precious Metals
  • Commodities

Diversification is an important feature of ETF's.  In today's volatile markets, investors will appreciate the cushion that diversification can offer.  Corporate scandals are now a common event on Wall Street.  Investors who own individual stocks can be subject to some very large losses in a short period of time.  It doesn't make sense over the long term to subject your portfolio to the fortunes of a few companies.  ETF's avoid the pitfalls that "single stocks" can cause.  They cutout the excess risk that exists when investors "micro" manage their investment portfolios with individual stocks.  Over the long haul, less risk and greater reward will be achieved by managing your portfolio with a "macro" investing approach (using ETF's).

Want to know the advantages of using ETF's over Mutual Funds?  For one, they're more cost effective.  Since ETF's are not actively managed, the costs to operate them (internal expenses) are much lower than mutual funds.  And mutual funds have a poor track record of keeping up with the index they aim to outperform or track.  Some studies suggest that over 90% of all mutual funds under perform the index they compare themselves to.  ETF's are also more liquid than mutual funds.  They can be bought and sold at any time during the trading day.  This enables investors to take advantage of short term market opportunities.  However, mutual funds only trade once a day (at the market close).  ETF's are also more tax efficient.  They allow investors to pay most of their capital gains on the final sale of the ETF, delaying it until the very end.  Mutual fund investors are at the mercy of their fellow shareholders when it comes to taxes.  If fund managers need cash to meet investors' redemptions, they may have to liquidate holdings in the portfolio, possibly generating a capital gain.  And those gains are passed along to all shareholders.  It's not uncommon for mutual funds to distribute capital gains in a year where the fund has a negative performance.  ETF shareholders have more control over their tax destiny because they are not impacted by fellow shareholder purchases and redemptions. 

ETF's are rapidly changing the way investors manage their investment portfolios.  No other investment vehicle can provide all the advantages of using ETF's. They are the ideal tool for the investor focused on what is most important, asset allocation.