by Ian Harvey
Perhaps no vehicle is helping to change the investment landscape more than Exchange-Traded Funds (ETFs).
As with any investment, it is important to understand the product you are using in your portfolio. So before you decide to include ETFs in your investment stratagem, you should understand the basics about Exchange-Traded Funds.
Once you understand the basic concept of an ETF, then you can find out what you need to do in order to get started trading Exchange-Traded Funds.
An "Exchange-Traded Fund (ETF)" is a security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. ETFs experience price changes throughout the day as they are bought and sold.
Exchange-Traded Funds are much like mutual funds with two key differences. First, they can be freely traded like stocks, while mutual fund transactions don't occur until the market closes.
Secondly, expense ratios tend to be lower than those of mutual funds because many are passively managed vehicles tied to an underlying index or market sector.
The Benefits of Exchange-Traded Funds
The primary benefit of Exchange-Traded Funds is that they can be used to construct entire portfolios that can be traded easily. Also, they offer investors the ability to diversify over an entire sector or market segment in a single investment -- they are usually well diversified due to the fact that they are designed to replicate a specific index or sector.
Because it trades like a stock, an ETF does not have its net asset value (NAV) calculated every day like a mutual fund does.
By owning an Exchange-Traded Fund, you get the diversification of an index fund as well as the ability to sell short, buy on margin and purchase as little as one share. Another advantage is that the expense ratios for most Exchange-Traded Funds are lower than those of the average mutual fund. When buying and selling Exchange-Traded Funds, you have to pay the same commission to your broker that you'd pay on any regular order.
One of the most widely known Exchange-Traded Funds is called the Spider (SPDR), which tracks the S&P 500 index and trades under the symbol SPY.
Exchange-traded funds can be a valuable component for any investor's portfolio, from the most sophisticated institutional money managers to a novice investor who is just getting started.
Some investors use Exchange-Traded Funds as the sole focus of their portfolios, and are able to build a well-diversified portfolio with just a few Exchange-Traded Funds. Others use Exchange-Traded Funds to complement their existing portfolios, and rely on Exchange-Traded Funds to implement sophisticated investment strategies. But, as with any other investment vehicle, in order to truly benefit from ETFs, investors have to understand and use them appropriately.