ETFs 101: The Basics
The simplest definition for ETFs is that they are index funds that trade on the stock market exchanges. An ETF consists of a virtual basket of stocks that usually tracks a specific index or sector. To put it another way, ETFs are like a homologous species of mutual funds that allow investors to buy into a specific area of the market without all of the hassles, management fees and trading restrictions imposed by traditional mutual funds.
ETFs and mutual funds are similar in that they both offer access to an underlying pooled portfolio of assets. Both offer instant diversification, and both give you the ability to invest in the domestic and international markets, as well as in specific market sectors.
ETFs and stocks are similar in that they are both bought and sold on an exchange-NYSE, Amex or NASDAQ-throughout the trading day.
Keep in mind that like stocks, you must pay brokerage commissions to buy and sell ETFs. However, there are no sales loads on ETFs like there are on mutual funds, and internal expenses are typically far less than those of comparable mutual funds.
4 Main Benefits of Using ETFs
Benefit #1: Lower Expenses
While the Fabian family have been big advocates of mutual funds for the past three decades, most mutual funds are just not cutting it when it comes to performance. The number one reason for this stems from a mutual fund’s high annual expenses.
Because the managers of ETFs are not actually buying and selling stocks (and generating exorbitant fees along the way) in an effort to outsmart the market, ETFs have it all over mutual funds when it comes to lower expense. The average annual fees and expenses for a mutual fund is approximately 0.99% (according to the Investment Company Institute 2009 survey), while the average annual expenses for ETFs range between 0.1% and 0.6%.
Benefit #2: Liquidity
ETFs are as liquid as individual stocks. One of the biggest struggles we have with mutual funds is they only price at the end of the day. We feel this exposes your serious money to potentially devastating losses should the market have a significant one-day drop. Since ETFs trade like stocks, they offer the ability to buy or sell any time of the day. This provides investors with some added flexibility, along with the reassurance that they don’t have to wait until the end of the trading day to get the price of their investment.
Benefit #3: Global Opportunities
There are over 1,000 ETFs out there to choose from, and that number is growing rapidly. But ETFs are not just relegated to the domestic stock market. There are currently more than 200 ETFs focused on the international markets. From broad-based international indexes to emerging markets to country-specific ETFs, the panoply of global ETF offerings allows investors a way to get exposed to some of the alternative market segments out there.
Benefit #4: Instant Diversification
Like mutual funds, ETFs provide investors with instant diversification. Because ETFs usually mirror the performance of a particular market sector index, you get the diversification of owning every company in that index. For example, if you were to buy the SPDR 500 ETF, you in essence get the diversification of owning 500 of the world’s biggest companies.
These are just some of the reasons why Fabian Wealth Strategies trades a large portion of our portfolios using Exchange Traded Funds.
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