 ETFs Are a Great Investment Strategy
How Long Before They Replace Mutual Funds?
ETFs give the investor a way to "own" all the stocks in a broad group, like the Dow Jones Industrials or all the stocks in the Standard & Poors 500 Index. Better yet, ETFs are easy to buy and sell because they trade on the stock exchange just like stocks.
Every day I get up and look through the Forbes list of the richest people in America. If I'm not there, I go to work. ~Robert Orben
 What is an ETF?
An exchange-traded fund is also known as a unit investment trust. It is a collection of securities such as stocks or bonds that are bundled together in a special entity that happens to be a trust. Investors can buy tiny little pieces of the trust, called units. A Unit Investment Trust looks like a mutual fund in that it bundles things together and sells shares. However, there are two big differences. - The units of the ETF are listed on a stock exchange.
They trade just like stocks. - The trust holds the same securities that are in a stock index,
like the S&P500 or the DJIA. - The Trust holds the portfolio of securities and cash, and is not actively "managed" by traditional methods.
The purpose of the ETF trust is to hold a portfolio, a basket of securities, which is set up to mirror a major stock index like the Dow Jones Industrial Average, the Nasdaq 100 or the Standard & Poors 500. There are also ETFs which mirror a sector index or a commodities index or a country index.
There are two primary ways to "own" an index. The conventional way is to buy an index mutual fund such as the Schwab S&P 500 Fund (SWPIX). With the advent of the ETF, investors now have another way to “own” a index.
ETFs are unit investment trust securities certificates that state that you legally own part of a basket of individual stock certificates issued by registered investment companies. ETFs trade throughout the day on an exchange just like a stock.
The new source of power is not money in the hands of a few, but information in the hands of many. ~John Naisbitt in Megatrends
Some Stellar ETFs
ETFs are becoming very popular investment vehicles. There are at least 440 ETFs to choose from and another 288 are pending approval by the Securities and Exchange Commission. You can buy ETFs based on any major stock market index, by category or core economic sectors. There are ETFs that track the MCSI Emerging Markets Index, the Homebuilders Index and the Utilities Index. But the most popular and the most active ETFs are those that track large well-known stock indexs.
One of the most actively traded ETFs is the SPDR Trust Series 1, known as Spyders, which trades with the symbol SPY. This investment is a unit investment trust set up to mirror the S&P 500 Index. The SPDR Trust is an exchange-traded fund that holds all of the S&P 500 Index stocks. It has an expense ratio of .09% and has gained 20.4% over the past 12 months.
Another very active ETF is the PowerShares QQQ Trust, which trades under the symbol QQQQ. This is a unit investment trust designed to mirror the Nasdaq-100 index, before fees and expenses. It has an expense ratio of .2% and has gained 23.10% over the past 12 months.
Similarly, the Diamond Trust Series 1 mirrors the Dow Jones Industrial Average. It has an expense ratio of .17% and has gained 22.61% over the past 12 months.
Advantages of ETFs and Index Funds
Exchange Traded Funds, ETFs for short, are similar to index funds that are based on a stock index. Investors have figured out that managed mutual funds often underperform the stock market averages. This is due in part to fees charged by the fund. Investment companies began creating baskets of stocks tied to market indices. The composition of stocks in the basket is exactly the stocks in the market index. The index fund buys or sells a company stock only rarely, when the company is included in the market index. Thus, index funds thus do not need active managers doing expensive research analysis and frequent trades.
Instead of trying to outguess the market, the theory of ETFs and index funds is that your money will always do as well as the market average, although it will never have exceptional results. The strategy of investing in index funds has proven itself a winner many times. For example, the Vanguard 500 Index Fund outperformed 80% of actively managed large-capitalization mutual funds over a period of 20 years.
More Advantages of ETFs
The primary benefit of an ETF is to earn moderate gains and to minimize risks by investing in a broad basket of stocks linked to a stable market index. However, there are ETFs available for every investing purpose.
- Lower Cost You benefit from the lower expenses and tax efficiency of index and ETF funds. The expenses of an ETF are often as low as .07%, while the expenses of a managed mutual fund are often more than 1% of your money every year. Internal transaction costs are low, because the composition of securities in the ETF seldom changes.
- Ease of Trading ETFs are simple to own. The primary advantage is that ETFs trade all day on the stock markets, just like company stocks. It is easy and convenient to purchase and sell them.
- Transparent Cost The investor knows immediately how much the purchase will cost. ETF shares trade in the marketplace, whereas index funds and mutual funds are purchased through their managers. Index and mutual funds are priced at the end of each day, and the investor who mails in a check pays the price in effect on the day the fund receives the check.
- Tax Advantages ETFs and Index funds have an advantage over mutual funds when tax time comes, too. A mutual fund must distribute its capital gains to the investor once a year. The gain is paid, not as cash, but as more shares of the mutual fund. Even though the investor receives no cash, the investor must pay capital gains tax on the distribution.
- Trading Opportunity With ETFs, there are trading and arbitrage opportunities with ETFs for the aggressive trader. Sometimes, the trading price of the ETF may not reflect the actual Net Asset Value of the underlying securities. The price of the ETF changes as it is traded on an exchange, but its Net Asset Value is based on the value of the index it mirrors. This means that ETF may be trading at a small discount or a small premium compared to its Net Asset Value. Furthermore, ETFs can be shorted and bought on margin, like stocks.
- Diversifying a Portfolio If there are sectors you want to invest in, there’s probably an ETF fund that will fill the bill. For example, you could buy a semiconductor ETF which mirrors a semiconductor index. Some of the more specialized ETFs in a narrow sector can be top-heavy with a few large companies. This defeats the purpose of ETFs and index funds, which is to reduce risk and earn moderate returns with a broad basket of stocks in a broad stock index.
- Speculation For active traders willing to do their homework, there are narrowly focused ETFs that offer exceptional opportunities. There are even more speculative ETFs that are tied to commodities, or exotic ETFs that are tied to a single currency like the Swedish krona or the Mexican peso. There’s even an ETF fund for investor who expect oil prices to rise and a sister fund for those who think oil prices will fall.
For the Conservative Investor
Unquestionably, ETF funds that mirror broad stock indexes, like the Spyders and the Diamonds, are excellent for even the most conservative investor. They provide the balance and mix of stocks that a small investor cannot reproduce in a portfolio. And will ETFs replace mutual funds? For most investors, ETFs should definitely replace mutual funds in their portfolio. But will mutual funds die out? Hardly. Mutual funds will sometimes have a temporary hot streak, when investors pile in. Managed mutual funds will continue to be sold, as long as fund managers can grow wealthy off the investors who don’t know better.
My wish is that your life brings you much success. I hope you have a very happy day.
-----Surfer Sam
If you liked this post, buy me a latte
> > Please return to the top.
Now that you've smiled at least once, it's your turn to spread the happiness and send this to someone you want to share with.
Email this page link to a friend.
Howdy! Welcome to Surfer Sam and Friends. Our Free Online Magazine gives you blogs, funny jokes, famous quotes, funny stories, clean funny pictures, games, travel and sage advice. We've also got free ecards - Surfer Cards - for you to email. So enjoy yourself here. Chill out and relax. Meet the gang. And thanks for helping out, mate. Life's a beach!
 
|
Our Magazine
Blogs, Podcasting
