ETFs 101
For many years, investors have attempted to diversify their overall portfolios by trying to pick stocks across a diverse set of asset classes. Which is all well and good, but the problem it generally runs into is you should also be diversified within any given asset class, lest something adverse happen to the company you happened to bet on. Yet as soon as your diversifying both within, and between asset classes, now your running a portfolio of potentially 40+ equities, and even the active investor rarely has time to do due diligence on the hundreds of companies required to find 40 excellent investments.
Exchange Traded Funds are the answer. Exchange traded funds (ETFs) allow you to invest in a group of companies all at once, similar to a mutual fund. The difference is that ETFs are traded directly on a stock exchange just like a stock, they can be bought and sold any time during the day without penalty, and they are both shortable, and optionable allowing you to take advantage of both up, and down moves in the market.
ETFs can focus on certain regions; China for instance, is represented by the FXI. ETFs can focus on certain sectors; Those playing financial stocks may find XLF interesting. It can even focus on certain capitalizations; Those wanting diversification across small cap companies can make a single investment in IWM.
Yet if ETFs are so similar to mutual funds, why not just use a mutual fund. There really are a couple reasons to do so. First off, mutual funds have a history of underperforming the stock market as a whole after fees are included. This makes simple index investing, through an ETF representing a large basket of stocks, such as the SPY, an extremely effective way of matching the markets returns with nearly no cost. There are also slight tax advantages with ETFs compared to mutual funds. Mutual funds have to pay capital gains tax whenever they sell one of their holdings, and whenever they have a large wave of redemptions, they have to sell their positions to come up with the money. This leads to excess fees, some of which get passed on to the remaining investors.
Perhaps the biggest consideration is the simple convenience of owning ETFs when compared to mutual funds. They can be bought and sold (or shorted) any time during the trading day, using the same order types available to normal stocks. Free from redemption fees, the only deterrent from actively trading an ETF is belief in the efficient market hypothesis, and the standard commission costs from buying and selling stocks
Furthermore, ETFs are often optionable, so risk can be minimized with covered calls and protective puts, or " if your so inclined " much larger returns can be sought through buying calls and puts on the ETF. Experienced stock option experts may even use advanced stock option strategies, like iron condors and vertical spreads to increase investment returns.
One thing to note is that not all ETFs are created equal. While some simply hold a basket of stocks and use those to keep the ETFs value near the benchmark, many use other, more exotic strategies, with various degrees of success. QLD for instance, aims to gain roughly twice the daily returns of the Nasdaq composite index, and is usually fairly consistent when doing this. Another similar instrument is the ETN, which is actually a debt based instrument. While ETNs also aims to gain returns based on a given benchmark, there price is also sensitive to changes in the debt rating of the issuer, and this should be considered when investing in them.
ETFs are a powerful tool for both the intelligent investor, and the active trader. Their ability to hone in and diversify within a given industry, or region of the world is invaluable when riding the larger megatrends that happen periodically in investment. Similarly, the ability to trade them just like a stock, using techniques such as shorting, options, and the various order types make them an invaluable asset for the active trader. For those believing the efficient market hypothesis, they even allow passive index investing at a cost far below that of a mutual fund. - 23212
Exchange Traded Funds are the answer. Exchange traded funds (ETFs) allow you to invest in a group of companies all at once, similar to a mutual fund. The difference is that ETFs are traded directly on a stock exchange just like a stock, they can be bought and sold any time during the day without penalty, and they are both shortable, and optionable allowing you to take advantage of both up, and down moves in the market.
ETFs can focus on certain regions; China for instance, is represented by the FXI. ETFs can focus on certain sectors; Those playing financial stocks may find XLF interesting. It can even focus on certain capitalizations; Those wanting diversification across small cap companies can make a single investment in IWM.
Yet if ETFs are so similar to mutual funds, why not just use a mutual fund. There really are a couple reasons to do so. First off, mutual funds have a history of underperforming the stock market as a whole after fees are included. This makes simple index investing, through an ETF representing a large basket of stocks, such as the SPY, an extremely effective way of matching the markets returns with nearly no cost. There are also slight tax advantages with ETFs compared to mutual funds. Mutual funds have to pay capital gains tax whenever they sell one of their holdings, and whenever they have a large wave of redemptions, they have to sell their positions to come up with the money. This leads to excess fees, some of which get passed on to the remaining investors.
Perhaps the biggest consideration is the simple convenience of owning ETFs when compared to mutual funds. They can be bought and sold (or shorted) any time during the trading day, using the same order types available to normal stocks. Free from redemption fees, the only deterrent from actively trading an ETF is belief in the efficient market hypothesis, and the standard commission costs from buying and selling stocks
Furthermore, ETFs are often optionable, so risk can be minimized with covered calls and protective puts, or " if your so inclined " much larger returns can be sought through buying calls and puts on the ETF. Experienced stock option experts may even use advanced stock option strategies, like iron condors and vertical spreads to increase investment returns.
One thing to note is that not all ETFs are created equal. While some simply hold a basket of stocks and use those to keep the ETFs value near the benchmark, many use other, more exotic strategies, with various degrees of success. QLD for instance, aims to gain roughly twice the daily returns of the Nasdaq composite index, and is usually fairly consistent when doing this. Another similar instrument is the ETN, which is actually a debt based instrument. While ETNs also aims to gain returns based on a given benchmark, there price is also sensitive to changes in the debt rating of the issuer, and this should be considered when investing in them.
ETFs are a powerful tool for both the intelligent investor, and the active trader. Their ability to hone in and diversify within a given industry, or region of the world is invaluable when riding the larger megatrends that happen periodically in investment. Similarly, the ability to trade them just like a stock, using techniques such as shorting, options, and the various order types make them an invaluable asset for the active trader. For those believing the efficient market hypothesis, they even allow passive index investing at a cost far below that of a mutual fund. - 23212
About the Author:
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posted by X - Men @ 3:32 PM
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