Providing low-cost admission to almost every corner of the financial markets, ETFs allow investors to build institutional-caliber investment portfolios with lower costs than mutual funds and better transparency than ever before.
An ETF, or exchange-traded fund, is a security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold. ETFs typically have higher daily liquidity and lower fees than mutual fund shares, making them an attractive alternative for individual investors.
But what is an ETF? And how do ETFs provide these benefits?
An ETF is a pooled investment vehicle that offers diversified exposure to a particular area of the market. An ETF can invest in currencies, bonds, commodities, stocks, options or a blend of assets. Investors purchase shares of the ETF, which represent a proportional interest in the pooled assets of the fund.
An ETF is a mutual fund in every aspect … except one. And that’s a big one, which is hinted at in its very name: exchange-traded funds.
ETFs Are Exchange-Traded
As an exchange-traded fund, you buy shares in an ETF directly from any brokerage account. Just like you buy shares in a stock, you can enter a buy or a short order in your broker account and buy any ETF you want.
You can also trade ETFs almost whenever you want. While orders to buy or sell a mutual fund can be processed only once per day (after the close of trading), ETF trades can take place any time the market is open. You can buy shares in the morning and sell them in the afternoon. You can buy them at 10 a.m., sell them at 11 a.m. and buy them again after lunch if you want.
An investment advisor can perform all types of stock-like strategies with ETFs that could never be done with mutual funds: placing stop-loss or limit orders, selling short and even buying on margin. This definitely gives the ETF the win for better market flexibility over the once reigning mutual fund.
Evolution of the ETF
According to MarketWatch, there are over 4,400 ETFs globally with over 4.56 trillion dollars invested . A decade ago, the ETF lineup consisted primarily of “plain Vanilla” products linked to well known stock and bond indexes. In recent years, the pendulum has swung to the other end of the granularity spectrum; many of the new additions to the ETF universe are hyper-targeted in nature, focusing on narrow segments of the U.S. and international equity markets. In reality, many of these hyper-targeted ETFs are being scooped up by investors and tactical traders looking to fine tune their portfolios. A handful of hyper-targeted funds have been rather successful, indicating that there is room in the ETF industry for both blunt and precise instruments. A few of the noteworthy highly targeted ETF early successes: cloud computing, fertilizers, lithium and marijuana.
ETFs vs Mutual Funds
The fact that ETFs are “exchange-traded” creates a series of other benefits that, according to many market observers, makes them a better overall choice than traditional mutual funds for many reasons: lower costs, better tax efficiency and more.
read more: Mutual Funds vs ETFs
Advantages of ETFs
ETFs give investors the diversification of an index fund as well as the ability to buy on margin, sell short, and purchase as little as one share as there are no minimum deposit requirements. A second advantage is that most ETFs expense ratios are lower than those of the average mutual fund. Purchasing ETFs is quite simple. The same as a stock transaction. Plus, there are no potential front end loads, back end loads, penalties for selling with 60 days, or expensive broker commissions.
Plus, with ETFs, there exists the potential for favorable taxation on cash flows generated by the ETF, since capital gains from sales inside the fund are not passed through to shareholders as they commonly are with mutual funds
Are ETFs Better?
In sum, an ETF is an investment vehicle that allows investors to have access to different corners of the market—everything from U.K. equities to Chinese tech stocks to high-yield bonds, spot gold bullion and more—at low costs, from the comfort of a traditional brokerage account.
ETFs are like a mutual fund, only better. Or, perhaps, a mutual fund: version 2.0.
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Simply put, Research Financial Strategies is focused to place clients—and client success—over everything else. It’s a commitment to performance.
read more: Mutual Funds vs ETFs