What to Know About Exchange Traded Funds


If you are new to the world of investing, or if you have caught the investment bug and love the thrill of finding new ways to diversify your portfolio, you may be wondering about Exchange Traded Funds, or ETFs. The following information can help you gain a basic understanding of ETFs to determine if you are interested in talking to your financial advisor about getting started investing in them.

Exchange Traded Funds are funds that track indexes such as the Dow Jones, S&P 500 and the NASDAQ 100 Index, among others. Shares represent part of the portfolio tracking the yield and returns of its index.

If you are new to the world of investing, or if you have caught the investment bug and love the thrill of finding new ways to diversify your portfolio, you may be wondering about Exchange Traded Funds, or ETFs.“The main difference between ETFs and other types of index funds is that ETFs don’t try to outperform their corresponding index, but simply replicate its performance,” states NASDAQ.com. “They don’t try to beat the market, they try to be the market.”

They are generally managed in a passive management style. This means that only minor adjustments are made based on how the index is doing. This is a huge difference compared to the frequent changes that  are a hallmark of most actively managed mutual funds. Because the goal of mutual funds is to beat the market, the managers are always looking for investment opportunities that could mean big success and shedding investments that are underperforming.

“For these reasons, ETFs mitigate the element of ‘managerial risk’ that can make choosing the right fund difficult,” according to NASDAQ.com. “Rather than investing in a fund manager, when you buy shares of an ETF you’re harnessing the power of the market itself.”

There are many more benefits to ETFs, explaining their growing popularity in recent years. One of the most obvious benefits is that they are traded like stocks, which means that they are not priced just once per day like a mutual fund, but at many points throughout the day. This allows investors to speculate and take advantage of fluctuations in the market, essentially trading entire indexes as if they were a stock.

ETFs can also save investors money. “They offer all of the benefits associated with index funds – such as low turnover and broad diversification (not to mention the often-cited statistic that 80 percent of the more expensive actively managed mutual funds fail to beat their benchmarks) – plus ETFs cost a lot less,” states Investopedia.com.

ETFs can also provide you with benefits at tax time. They are considered tax efficient because investors who trade big volumes are eligible for in-kind redemptions, i.e. shares of stocks that are tracked by the ETF.

“This arrangement minimizes tax implications for the investor exchanging the ETFs since the investor can defer most taxes until the investment is sold,” states Investopedia. “Furthermore, you can choose ETFs that don’t have large capital gains distributions or pay dividends (because of the particular kinds of stocks they track).

One thing to consider is that due to the fact that ETFs are traded through a brokerage firm, there is a commission charge associated with each trade. There are low cost brokerages, however, so if you shop around, you can find ways to minimize this cost.

“Investors interested in passive fund management, and who are making relatively small investments on a regular basis, are best advised to stick with the conventional index mutual fund,” states Investopedia. “The brokerage commissions associated with ETF transactions will make it too expensive for those people in the accumulation phase of the investment process.”

Now that you know the benefits of ETFs, and whom they are best suited to, you can have an informed talk with your financial advisor and decide if they are right for you.

 

Related Articles

Leave a Reply