Exchange Traded Fund ( ETF )An exchange traded fund or ETF gives you the advantages of a mutual fund but with some added twists. To understand what an this type of fund is, let's first review what a mutual fund is. A mutual fund is a pool of money collected from many hundreds or thousands of investors. The fund manager uses the money to purchase stocks and bonds within certain guidelines set for the fund. Usually mutual funds are set up to track an index, market sector, or certain types of bonds. As a result the money manager will use the money to buy stocks that makeup whatever index or sector the fund is tracking. An exchange traded fund is almost like that. But rather than being a pool of money, an exchange traded fund is a pool of shares. So a large financial institution will invest in say the stocks that make up the S & P 500, and then slice up that investment into individual shares representing the entire index that are traded on the stock market. Like a mutual fund, an ETF will track a certain sector of the market, be it an index or say the utilities sector. At this point the differences might seem fuzzy. So how are they different as a practical matter for the small investors portfolio?
ETF vs. Mutual FundIf you want to invest in a mutual fund, you will have to go to a firm like Fidelity or T Rowe Price and pony up a few thousand dollars for the initial investment. You can then buy more shares which are priced once a day at the "net asset value". In contrast, an exchange traded fund is traded on a stock exchange just like any other share of stock. You could sign up with an online broker such as ShareBuilder and start trading shares of an ETF. Since they are equities, shares of exchange traded funds can be bought and sold any time the markets are open, and their prices change throughout the day. Unlike a mutual fund, exchange traded funds require no minimum investment other than the price of a single share.
An ETF gives you a Diversified PortfolioImagine being able to invest in the entire S & P 500, the Dow Jones Industrial Average or the large-cap sector of an emerging market. To buy that many stocks you'd have to be incredibly wealthy. Well that's not true anymore. With the advent of exchange traded funds, small investors can quickly build a diversified portfolio. When you buy a single share of an exchange traded fund that tracks a given index or market sector, you're buying a small slice of the stocks that make it up. Consider SPY, the SPDR shares S & P 500 index. You can buy a single share for a relatively small amount as its priced at 1/10th the S & P 500 index (in late 2009, it was going for about $110 a share). Never before in the history of investing has so much opportunity been available to small investors. With just a few hundred dollars, you can have investments allocated across 500 different stocks.
Low Investment CostsIn addition to ease of trading, an ETF will typically have lower costs than a mutual fund. The costs associated with an ETF are certainly lower than those associated with actively managed mutual funds. Most of the costs associated with the fund are going to be associated with the trading fee you pay your broker, which these days might about to $10 at the most. Since an exchange traded fund is already made up of stocks and sliced up, there isn't an active money manager that you have to pay for to manage the investments.
ConclusionAn exchange traded fund gives you the opportunity to invest at low cost in a diversified array of stocks, bonds, and even precious metals and commodities. They are easy to manage because they trade like individual stocks, and you can buy and sell them at any time the markets are open. ETF for foreign investing Have a contribution to share about this topic?Do you have a great story about this? Share it! |