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What
is an Exchange Traded Fund (ETF)?
ETF stands for "Exchange Traded Fund".
Exchange Traded Funds are Collective Investment schemes. Collective
investment schemes are ways of investing money with other people
in order to participate in a wider range of investments. Collective
investments schemes are usually referred to as Mutual Funds,
Managed Funds or simply Funds. These funds account for a large
portion of the trading on most stock exchanges.
While the structure of ETF's vary around the world, major
common features include:
An exchange listing and ability to trade continually.
They are often index linked instead of being actively managed.
These qualities give ETF's some advantages over Mutual Funds
in the US. ETF's allow for a diversified portfolio at a low
cost. They can be used in both long term buy and hold and for
selling short and hedging strategies.
Typically
ETF's replicate a stock market index, such as Standard and Poor's 500, or the Hang Seng index.
They may also contain
stocks from a specific market sector such as energy, or a commodity
such as gold. They often have amusing or catchy, upbeat names
like, "Diamond" and "Spider". ETF's are
most commonly found on the AME or American Stock Exchange.
Today's ETF's Present an alternative to the traditional open
ended Mutual Funds. The Open ended index funds are particularly
good for this type of use.
History
The first ETF was introduced on the Toronto Stock Exchange
in 1989. There are now over one hundred ETF's traded on the
American Stock Exchange (AME) Since the introduction of SPY
on the AME in 1993, ETF's have become increasingly popular,
because they offer the diversification benefits of a Mutual
Fund with the features of stock. As more and more ETF's become
available, it is likely their popularity will increase even
more. ETF's typically have lower expense ratio's and lower
turn-over rates than actively managed Mutual Funds, and this
can lead to them being more tax-favorable in the United States.
ETF's Versus Mutual funds
Mutual Funds do have an advantage for people who practice
dollar cost averaging, or like to invest a little bit of money
every month. Since ETF's are traded on the stock market every
trade has commission costs. Many Mutual Funds do not have such
costs. For investors who like to invest 100 USD a month, a
Mutual Fund may be cheaper.
There are however many advantages to ETF's and those advantages
are likely to increase over time. ETF's typically have a lower
expanse ratio than actively managed mutual funds, which may
charge 1-3% or more. Index funds are usually much lower and
ETF's are typically in the .1-1.5 range. Over the long term
these costs can make a sizable difference.
ETF's can also be more tax efficient. In the US when ever
a Mutual Fund realizes a capital gain, it must distribute it
to the shareholders at the end of the quarter. These gains
are taxable. Since ETF's are not redeemed by holders and are
instead simply sold on the stock market, investors only realize
capital gains when they sell their shares.
The most subtle and likely the most important benefit of an
ETF is that it acts like stock. Investors can carry out the
same sort of trades that they can with a stock. Investors can
sell short, use a limit order, a stop loss order, buy on margin
and invest as little money as they wish, since there is no
minimum investment requirement. Mutual Funds, of course do
not offer those features.
For example, an investor in a mutual fund can only purchase
or sell at the end of the day at the mutual funds closing price
while an ETF is continually priced during the day, so it is
not subject to this disadvantage.
Particularly for those investors who know and follow certain
indexes and want a diversified portfolio they can trade with,
ETF's offer advantages and afford ability.
For many ETF's you only need to get a discount brokerage account,
and many will let you buy just one single share to start with.
It's easy to see why they are popular. They are deceptively
easy and seem simple to acquire, and for those investors who
do more trading than buying in holding, they can be much easier
to use. But before you invest make sure they are for you. # # # # # SolveYourProblem.com : 2007
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