What is an ETF?
ETFs (Exchange-Traded Funds) are investment vehicles traded on stock exchanges, much like stocks. ETFs are a relatively recent innovation. The first ETF--a broad-based domestic equity fund tracking the S&P 500--was introduced in 1993.
"Exchange-traded" means shares that trade all day long on the major stock market exchanges. "Funds" are investing vehicles that hold dozens, hundreds, or even thousands of companies under one umbrella unified by a particular investing theme, such as companies that comprise the Dow or those with a business in the health care industry.
The easiest way to understand ETFs is to think of them as mutual funds that trade like stocks. ETFs and index mutual funds are similar in that they typically seek to match the return of a market index. When you invest in an ETF, you know what you're buying. ETFs follow an index, so there's no guessing.
Liquidity
ETFs trade like stocks on major national exchanges. Like stocks, ETFs are liquid and trade throughout the day like a single stock. You can get in and out of the fund and get pricing at all times during the trading day.
With ETFs, investors also benefit from sophisticated trading strategies such as hedging, diversification, and sector rotation, along with potentially lower tax liabilities. Because ETFs trade like traditional stocks and bonds, they allow speculative investors to bet on the direction of shorter-term market movements through the trading of a single security.
For example, if the S&P 500 is on a steep rise in price through the day, investors can try to take advantage of the rise by purchasing an ETF that mirrors the index (such as a SPDR), hold it for a few hours while the price continues to rise and then sell it at a profit before the business day closes. In contrast, investors with mutual funds that mirrors the S&P 500 do not have this capability. A mutual fund does not allow speculative investors to take advantage of the daily fluctuations.
Diversification
Because ETFs have no minimum investment, they are a good vehicle for diversified investing. You can purchase as little as one share and have an easy and targeted access to a specific sector.
Use ETFs for diversify your investments. Instead of choosing one stock, you can get exposure to several and spread the risk. For example, Technology Select Sector SPDR (XLK) holds both Google 4.6% and Yahoo 1.2%.
There are hundreds of ETFs available, and they cover every major index (those issued by Dow Jones, S&P, Nasdaq) and sector of the equities market (large caps, small caps, growth, value). There are international ETFs, regional ETFs (Europe, Pacific Rim, emerging markets) and country-specific (Japan, Australia, U.K.) ETFs.
Like any other publicly traded company, ETFs have ticker symbols (snappy ones, in fact, like Cubes, Spiders, and Diamonds). But instead of typing "MSFT" to buy Microsoft, for example, you enter "DIA" for the Dow Jones Industrial Trust, or "Diamond" ETF.
Exchange-traded funds are subject to risks similar to those of stocks. Investment returns will fluctuate and are subject to market volatility, so that an investor's shares, when redeemed or sold, may be worth more or less than their original cost. |
