10 Advantages of an ETF Exchange Traded Fund for Investors Like Us
Better Than Mutual Funds?
What Is an ETF Exchange Traded Fund for Investment
An ETF is an Exchange Traded Fund for investment. 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.
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 and placed in a trust. Investors can buy tiny little pieces of the trust, called units.
An ETF certificate states that you legally own part of a basket of individual stock certificates The ETFs are administered by registered investment companies. ETFs trade throughout the day on an exchange just like a stock.
Compare the Advantages of ETFs to Mutual FundsThe purpose of the ETF is to hold a portfolio, a basket of securities. Some ETFs are 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. Other more exotic ETFs are designed to hedge investment risk.
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How an ETF Compares to a Mutual Fund
An ETF is like a mutual fund because it bundles financial investments together and sells shares in the trust. However, there are two big differences between ETFs and Managed Mutual Funds.
Many ETFs own the same stocks that are included in a stock index. There are two primary ways to "own" an stock 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 stock index.
- The ETFs are listed on a stock exchange. They trade just like stocks, so you buy and sell them through your broker.
- Some ETFs hold the same securities that are in a stock index,
like the S&P500 or the DJIA.
- The ETF Trust holds the portfolio of securities, and is not actively "managed".
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 Popular ETFs for Your Investment Portfolio
ETFs are very popular investment vehicles. There are at least 440 ETFs to choose from. Another 288 more ETFs are pending approval by the Securities and Exchange Commission. You can buy ETFs based on any major stock market index, industry sector, 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 indexes.
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. You can expect the investment performance of the Spyder ETF to mirror the S&P500 index very closely.
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.
The primary use 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 other ETFs available for every investing purpose.
The Advantage of ETFs
The main advantage of ETFs that are based on a stock index is that they perform better than most of the managed mutual funds. ETFs and index mutual funds both share this advantage. 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 same as the stocks in the market index. The index fund will not change these stocks, unless a new 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, you can invest in these ETFs, knowing 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 managed mutual funds over a period of 20 years.
More Advantages of ETFs Over Mutual Funds
- ETFs have Lower Expenses. You benefit from the lower expenses of an 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. ETFs and stock index funds also share this advantage of lower cost.
- ETFs have 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. A stock index fund are more difficult than an ETF to buy and sell because the stock index fund does not trade on the stock markets.
- ETFs have Transparent Cost. The investor knows immediately how much the purchase will cost. ETF shares trade in the marketplace, whereas index funds and managed 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.
- ETFs have Income Tax Advantages. ETFs have an advantage over mutual funds when tax time comes, too. An actively managed 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. ETFs and index mutual funds are not actively managed and thus do not have significant taxable capital gains during the holding period.
- ETFs Diversify a Portfolio ETFs are an investment that will help diversify your 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 and thus they are riskier. However, most investtor buy ETFs for the same reason they buy index stock funds, to reduce risk and earn moderate returns with a broad basket of stocks in a broad stock index.
- ETFs offer Trading Opportunity With ETFs, there are trading and arbitrage opportunities for the aggressive trader in the market. 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.
- Use ETFs for Speculation ETFs offer opportunities for 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.
Should the Conservative Investor Buy ETFs
Unquestionably, ETF investment funds that mirror broad stock indexes, like the Spyders and the Diamonds, are excellent investments for even the small, conservative investor. They provide your portfolio with the balance and mix of stocks that a small investor cannot reproduce otherwise.
Will ETFs Replace Managed Mutual Funds?
Will ETFs replace managed mutual funds? For most prudent investors, ETFs should definitely replace managed mutual funds in their portfolio. But will managed mutual funds die out? Hardly. Managed mutual funds will sometimes have a temporary hot streak that attracts new investors. Managed mutual funds will continue to be sold, as long as optomistic investors are willing to pay the expense fees of fund managers.
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