ETF stands for Exchange Traded Fund. An ETF is a fund that aims to track an underlying instrument.
Investing in ETFs have been growing in popularity for many years, and there are now hundreds of funds tracking almost every instrument imaginable. The chart below illustrates how quickly they have grown
Some of the popular ETFs track stock indices, like the Dow Jones Industrial Average and the S&P 500. To accurately track an entire stock index like the Dow, the manager of the fund would need to buy stocks in all the companies in the index.
Other popular ETFs track oil prices. Many of these funds buy futures contracts to try and track the price of oil.
There are also ETFs tracking currencies, metals, gas, heating oil, wheat, milk, orange juice, lean hogs, T-bonds, coffee, cocoa and many more.
How to buy ETFs
Why trade ETFs?
There are many distinct advantages to investing in ETFs including:
Unlike conventional stocks, you can buy or sell ETFs. If you feel the price of the underlying instrument is going to fall, you can go short. There are also inverse ETFs that seek to profit when the underlying index is falling. These, however, are sophisticated, complex instruments, and are not suitable for every investor.
Many mutual funds have unjustifiably high management fees. This is often due to fund managers being greedy. The management fees on ETFs are typically significantly lower than a mutual fund. Some mutual funds even charge a startup fee. They seem to forget you are doing them a favor by giving them your money to “play” with. ETFs don’t have such charges.
It’s not as taxing!
One big advantage of ETFs is that you do not need to pay any tax on your gains until the ETF trade is closed. If you keep it open for 5 years, then there is no tax to pay during this period. This is different to a mutual fund where tax may be due on unrealized gains.
Moving ETFs to a new broker is usually much easier than moving mutual funds to a new broker. Usually there are no costs involved, whereas moving mutual funds can be an expensive ordeal, especially if positions need to be closed and reopened.
Get your dividends quicker
With stock related ETFs dividends usually get priced into the fund much quicker than they do with a mutual fund.
Looking at the advantages I have talked about above, it is easy to see why Exchange Traded Funds have become so popular in recent years.
There is something I feel I must make clear, as I have talked about ETFs in a positive light, as I do like them. There is no guarantee that an ETF will accurately track the underlying instrument. Most ETFs do track the underlying accurately, it can be a good idea to see how well a particular fund has tracked the underlying in the past before investing.
As with every investment, there are risks associated with these instruments, and you should review the holdings in the ETFs to assure its suitability for your investment objectives. Always research every potential investment carefully prior to committing any capital.