An ETF, or an exchange-traded fund, is a basket of stocks that trades like a common stock on the sTock exchange.
Compared to mutual funds, ETFs usually have lower fees and higher daily liquidity. For these reasons, many individual investors consider ETFs to be an appealing option. Shareholders are indirect owners of these assets.
More than $2 Trillion have been invested in ETFs since their introduction. ETFs were introduced in the U.S. in 1993 and by the end of 2015 ETFs offered “1,800 different products, covering almost every conceivable market sector, niche and trading strategy.”
An ETF owns the underlying assets and divides ownership of these assets into shares.
What ETFs are and Why Do Investors Like Them
ETFs offer investors a more diversified portfolio, much like that of an index fund, as well as more options regarding how to handle their shares. Investors can purchase as little as one share and can buy on margin and sell short.
ETF shareholders are entitled to a portion of the profits in the room of earned interest or dividends. Because ETFs are traded on public stock exchanges, ownership of the fund can easily be bought, sold, or transferred in a similar fashion to stock shares.
ETFs also provide the potential for more favorable taxation since capital gains from sales inside the fund are not passed to shareholders. Mutual funds commonly are. They also offer lower transaction and management costs. In addition, their higher daily liquidity makes them an alluring alternative for individual investors.
What are the Most Common ETFs and Where Can I Find Them?
One of the most well-known and widely traded ETFs is the Spider (SPDR), traded under the ticker SPY. It tracks the S&P 500 Index. The DIA tracks the Dow Jones Industrial Average, the IWM fund tracks the Russell 2000 Index, and the QQQ tracks the Nasdaq 100.
There are also sector-specific ETFs that track individual industrials such as the OIH which tracks, oil companies, XLE for energy companies, BBH for the biotech sector, XLF for financial companies, and so on. Commodity ETFs track commodity prices such as gold (GLD), silver (SLV), crude oil (USO), and natural gas (UNG).
There are also ETFs that track foreign stock market indexes as well as those that follow global currency movements. For a comprehensive resource on all available ETFs check the ETF Database.
Why ETFs are a great option for the online investor
For the online investor, ETFs hold additional appeal for their ease of entry. They are easier to buy than mutual funds – you don’t need to sign up for accounts or worry about transaction fees – and they have the same advantages of mutual funds. They provide a diversified portfolio as well as access to specific areas of the market.
ETFs also provide several advantages over mutual funds. First of all, ETFs are constantly updated throughout the day, whereas mutual funds are only updated at market close. Intraday trading allows more speculative and active investors to bet on shorter-term market movements.
Investors interested in accessing specific areas of the market such as precious metals or commodities can easily do so through the sector-specific ETFs.
For active investors, ETFs also offer options, such as short selling and trading on margin. ETFs also make a lot of sense for buy-and-hold investors.
ETF Fee structure: how they can work in your favor
The fees for ETFs are also typically significantly lower, and ETF investors rarely get taxed on capital gains. Dividends, on the other hand, are taxed. ETFs can be even more tax-efficient than index funds. ETFs don’t just offer low turnover—one of the benefits of indexing—but the structure of ETFs enables large trade volume investors to get in-kind redemptions. These investors can redeem the ETF for the shares of stocks that it tracks.
ETFs are lower cost than mutual funds and behave in a similar way to index funds. That said, not all ETFs are structured to imitate index funds. As Mitch Tuchman advises, “If you want to have the flexibility of an ETF’s low trading cost and performance similar to an index fund, it’s best to use only the largest, most widely traded ETFs on the market, the ones designed to match well-known benchmarks and which have track records demonstrating their accuracy.”
Buying and Investing in ETFs: The Takeaways
When seeking out a cost-advantageous ETF with low fees and commissions, shop for a low-cost brokerage.
ETFs offer a lower-cost option compared to mutual funds, but brokerage commissions may render them too expensive for investors in the accumulation phase of investment.
All in all, ETFs offer many advantages that make their popularity easy to understand. Costs are low and portfolios are flexible.