What are ETFs?
An exchange traded fund (ETF) is a marketable security that trades like stock on a stock market. Created by Wall Street firms for individual investors, it is made up of underlying assets such as stocks or bonds . The investment objective of an ETF is simply to match the return or performance of specific index . For example, the Vanguard S&P 500 ETF (VOO) will try to match the return of the S&P 500 index. That means that instead of buying one or more stocks outright, ETF’s are a way to purchase a representative share of an entire index. Fintalent’s ETFs consultants note that ETFs have been gaining market share in recent years as investors have come to appreciate their low cost and ease of use.
A benefit is that funds can be traded like stocks, which means they can be bought and sold at any time during the day (usually while they are liquid) with no commission fees. The investor may decide to buy and sell shares several times in a day. If so, this might mean trading against other investors in a very competitive market environment .
ETFs work just like mutual funds, but they trade like stocks. They are bought and sold on a stock exchange. ETFs generally have low expenses which can make them suitable for long-term investing . They are appropriate if you want to make a single major purchase of investments such as stocks or bonds. Investors should be aware that some ETFs are leveraged , which means that they attempt to achieve returns greater than the index they track. Investors need to be very careful when trading in an overheated market, or when there is negative news about a security that is held.
Are ETFs a good investment?
Investors should keep in mind that like any other type of investment, ETFs have associated risks . Like mutual funds, there is usually a minimum investment amount to open an account. Some ETF’s have higher minimums than others, which can restrict the investor’s ability to trade in and out of positions quickly. In addition, investors should take note of the expense ratios charged by each ETF provider. Many ETFs will charge annual fees to cover the management fees charged by the underlying investments. These fees may not be reflected in their published expense ratios. Investors should also consider how long an ETF fund has been in operation and how much turnover it has experienced. Mutual funds are actively managed by portfolio managers who try to adjust risk profiles as a fund evolves. This may mean that they will add more leverage or greater foreign exposure as time goes on. ETFs may not be as active, especially if they are index funds .
ETFs are designed to produce some return. They must meet the investment objectives of their underlying investments, which means that they may not perform well when the underlying market moves sharply. In addition, ETF’s can be less liquid than comparable mutual funds, which can lead to more expensive trading fees. Investors should also realize that there is no guarantee that an investment in an ETF will outperform the underlying index upon which it tracks. This is because stock prices can fluctuate beyond the control of the manager, who is known as a passive portfolio manager compared to actively managed mutual funds. In addition, investors should note that not all ETF’s track indexes in exactly the same way. Check out some of the more popular ETFs and their underlying indexes for a better understanding of how they work.
The Bottom Line
You should never invest in an ETF without a clear understanding of the underlying investments and what risks are involved . They are not appropriate for all investors, and you should carefully consider whether or not they fit your specific investment objective . With that said, ETFs do have some unique advantages that can be useful to an investor. While it is important to keep in mind that they can be subject to the same risks as other trading instruments , the simplicity of investing in them is attractive to many investors. You can invest in a diversified portfolio of stocks, bonds or other investments without buying each one individually ; this makes it easier to monitor and manage your portfolio. You can also add to or subtract from a position without an up-front commission cost.