How Exchange Traded Funds Work Part I – -411
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Exchange traded funds are index funds which have advantages over open-end index mutual funds. ETFs trade all day long on the stock exchanges, may be purchased through any broker, have lower fund expenses than mutual funds, and have less likelihood of generating unwanted taxable gains than mutual funds.
There are a number of reasons, which we’ll discuss, for investing in index funds (Exchange Traded Funds or mutual funds) but let’s start with the fact that the S&P 500 index beats 80% of all actively managed funds. (And, an index fund has lower expenses than an actively managed fund, further enhancing its net return.) If you can invest in an index fund and be in the top 20 percentile of fund returns, that’s a pretty good place to start.
You can construct a well-diversified portfolio entirely out of ETFs. There are Exchange Traded Funds for almost every type of investment you can imagine. Exchange Traded Funds enable you to diversify into assets which you may not otherwise feel comfortable owing because of expertise, risk and/or liquidity issues. They are well-suited for investing in exotic areas such as currencies and commodities. Of course, they’re great for sectors such as small cap or international stocks.
One of the most attractive features of Exchange Traded Funds is their ability to provide you with greater liquidity than if you were to directly own their underlying investments. Take municipal bonds, for example. Most Muni issues trade infrequently and the transaction costs for the individual investor are substantial. Minimum investment size can be another problem. Munis typically have a $1,000 denomination and trade in large blocks. ETFs are the answer to all these issues. You can buy as little as one share of an ETF (generally less than $100) during market hours and at the same cost as for a stock.
You can hedge an investment and/or lock in gains using ETFs. Unlike open-end mutual funds, Exchange Traded Funds can be bought on margin and shorted. Investing on margin can magnify your returns and your losses. The ability to short enables you to make money when something goes down in value. Think shorting the dollar or home building stocks. However, to paraphrase TV commercials, these strategies should only be employed by a professional driver on a closed course.
It’s also important to note that you don’t have to short an ETF if you think an asset is going to decline in value. You can probably find an ETF which is structured to generate an inverse return to that asset. ProFunds Group has a number of ETFs designed to perform this way. So, for example, if you think the Chinese stock market will decline, you can purchase a ProFund which should increase in value if you’re right.
All ETFs, even those which track the same index, are not the same. One S&P 500 ETF may weight its stock holdings by market cap, another may weight them all equally. This will result in different returns. Two ETFs which track the technology sector may hold different stocks and/or in different weightings. Since most indexes are not strictly defined, think technology versus S&P 500, there will be a variety of different investment strategies employed.
Different strategies to mimic an index are not good or bad, but they may have different risk levels and will produce different returns. Some ETFs also use leverage to enhance their returns or structure there holdings to magnify any gains (thus, also losses) of an index. You need to know what you’re investing in. To understand how a specific ETF works, visit its website and read its prospectus.
Within five years most investors will have at least one ETF in their portfolio. Also, within five years, there will be more money invested in ETFs than in open end index mutual funds. The advantages of Exchange Traded Funds-liquidity, transparency and lower expenses, to name a few-will force changes in open end mutual funds. Happily, the investor will be the winner in the competition between these two investment vehicles.
Watch the video related to exchange traded funds
Exchange Traded Funds or ETFs are an important Investment tool for a diversified portfolio, learn why
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Tags: education, etfs, Exchange Traded Funds, investing, investor, online, S&P Index, stock Market, trading
February 20th, 2010 at 9:53 pm
Yes, but the materiality rules apply. So it means you won't be able to audit Exxon Mobil because that stock is more than 5% of some ETFs.
February 20th, 2010 at 10:02 pm
ETFs are awesome. Really low internal expenses, less than 1% almost always. You can pick a sector, like healthcare, or international (EFA is a good one) or just mimic an index such as the S&P 500 (IVV). ETFs are traded like stocks, that is, you can set a limit order to buy and a sell stop to protect your downside or lock in your profits. This is not possible with a mutual fund. Mutual funds are valued at the end of each market day, and when you buy or sell, the value is calculated at the end of that day. ETFs are superior in every way and are traded in realtime, again, like a stock. Mutual funds are legally required not to be comprised of more than 5% of any one stock. This makes the mf manager (to whom you pay a hefty management fee) forced to sell the winners in their portfolio.
February 20th, 2010 at 11:27 pm
Title of the video is very wrong, instead of telling different types, you should have explained how they work!
February 21st, 2010 at 3:15 pm
First I think you are very smart to be thinking of investing in gold. The easy way is to buy Gold stock like GLD with say at e.g. TD Amertrade. Even as high as gold is today I think it is under valued if you compare to the weak dollar and inflation.
For centuries, buying gold has been recognized as one of the best ways to preserve one's wealth and purchasing power. Gold is a unique investment, one that has served mankind well for thousands of years. From the times of ancient Egyptians, Greeks and Romans to more modern times, man has been fascinated with the beauty and magic of gold, and with its power to change men's lives.
Gold bullion is real, honest money…and, many say, the best form of money the world has ever known. It is a store of value and a safe haven in times of crisis. Gold is rare, durable and does not wear out in the manner of lesser metals (or paper!) when passed from hand to hand. A small amount, easily carried, can purchase a significant amount of goods and services. It is universally accepted, and can be easily bought and sold around the world.
Today, the beauty of a gold bar lies in its ability to diversify investments, protect wealth and preserve one's purchasing power.
on.
February 22nd, 2010 at 12:40 am
VTI – Total Market Index
VB – Small Caps
VEU – International
BIV – Intermediate Term Bond
VTI gets you the entire us market.
VB – us small caps. I added this since VTI tends to be light in the small cap area.
VEU get you international stocks
BIV gets you fixed income exposure. Which in my opinion all portfolio's need.
I would use ETFs, only if you plan on making 1 lump sum contribution. If you plan on DCAing, I would use index funds instead.
February 22nd, 2010 at 10:53 am
Exchange Traded Funds are good vehicles as they have low expenses. They are not actively managed and have low expenses. I'm guessing the reason someone would tell you to put money into dividend paying stocks is that paying dividends is a reflection of a Strong balance sheet. In that sense I agree with the recommendation.
I believe you never put your eggs in one basket. I also like to be in a good managed no load fund as opposed to a passively managed funds such as an ETF. For my money I like small cap funds right now. I like RVT which is a closed end fund selling at a 17.6% discount now.
All that said I would never put more than 20% of my money in any fund.
February 23rd, 2010 at 11:24 am
China or better yet CWI or VEU (which I own)
February 23rd, 2010 at 7:39 pm
With only a few hundred dollars to invest,you can forget futures.
The initial margin on a mini futures gold contract is $2,500 .The initial margin on a normal gold futures contract is $7,600.
Even if you had the $2,500,a $20 short term temporary move in the price of gold against you would wipe you out.
Futures are not very secure.
The only choice you got is Exchange Traded Funds
The problem with futures is that you can get the long term direction correct but the short term reversals will wipe you out completely.You need a lot of capital to withstand these short term reversals.90% of all futures players lose because of this .Stay away from futures.
February 23rd, 2010 at 8:24 pm
As a professional financial planner, whom you may consider biased because I am paid by fees, I rank the amount of fees you pay, as a determinant of success in investing no higher than #9 on my list.
Thye product you choose: investment funds, stocks or ETF's really is irrelvant to much more important behavioural strategies. Don't spend more than a few minutes deciding on which product to use. Sepnd your time finding that rare financial advisor who can save you thousands of dollars every year in countless other ways, protect your family in case you cannot, put your kids through school, save your marriage and even your life insome cases.
February 24th, 2010 at 3:21 am
Look at your text book, it may hold the clue. If it does not, go to morningstar.com, the school probably has a subscription and look under their ETF tab.