According to Wikipedia, an ETF (exchange-traded fund) is, ‘an investment fund traded on stock exchanges, much like stocks. An ETF holds assets such as stocks, commodities, or bonds, and trades close to its net asset value over the course of the trading day. Most ETFs track an index, such as a stock index or bond index. ETFs may be attractive as investments because of their low costs, tax efficiency, and stock-like features.’ If you are more confused about what an ETF is after reading this long definition, think of an ETF as a basket of stocks, bonds or commodities that goes up and down in price in conjunction with the index it tracks. For instance, if you wanted to invest in the S&P 500 index, you could buy an ETF that tracks its price movement. For this example, do a Google search for ‘SPY’ to learn more.
Why use ETFs when putting together your investment allocation? Here are some of their advantages:
• Costs – ETFs generally have lower costs than other investment products because most ETFs are not actively managed. ETFs typically have lower marketing, distribution and accounting expenses, and most ETFs do not have 12b-1 fees (otheriwse known as ‘kick-backs’ to brokers).
• Flexibility – ETFs can be bought and sold at current market prices at any time during the trading day, unlike mutual funds and unit investment trusts, which can only be traded at the end of the trading day. As publicly traded securities, their shares can be purchased on margin and sold short, enabling the use of hedging strategies, and traded using stop orders and limit orders, which allow investors to specify the price points at which they are willing to trade.
• Tax efficiency – ETFs generally generate relatively low capital gains, because they typically have low turnover of their portfolio securities. While this is an advantage they share with other index funds, their tax efficiency is further enhanced because they do not have to sell securities to meet investor redemptions.
• Diversification – ETFs provide an economical way to rebalance portfolio allocations and to invest cash in a timely manner. An index ETF inherently provides diversification across an entire index. ETFs offer exposure to a diverse variety of markets, including broad-based indices, broad-based international and country-specific indices, industry sector-specific indices, bond indices, and commodities.
• Transparency – ETFs, whether index funds or actively managed, have transparent portfolios and are priced at frequent intervals throughout the trading day.
The ETF market has exploded over the past 10-years, currently net assets in all U.S. listed ETFs total $1.755 trillion. Their rise in popularity has also created a number of ETFs that are convoluted and if not used correctly can lead to unforeseen results. Therefore, as with all investments, make sure to do your research or consult with an investment advisor before making the leap into the ETF world.
- Brian Valenti
Generation Capital Management (GCM) is an independent, SEC-Registered Investment Advisor located in Rochester, NY. Since 2003, we have provided value to our clients through a premium level of investment service and an unbiased, effective investment process. If you have questions or need additional information, please feel free to contact us at: (585) 232 – 8560.