Exchange Traded Funds

Exchange traded funds offer a very wide range of investment opportunities and they represent the shares of ownership in either unit investment trusts or in depository receipts. Depository receipts hold the portfolios of common stocks that track the performance and the dividend yields of specific market indexes. Exchange traded funds, also known as ETFs, are like closed-end and open-end index mutual funds and they trade like stocks.  They provide the investor with the opportunity to buy and sell a selection of stocks in a single security, just like when selling or buying stocks per share. Exchange traded funds are actually traded on an exchange, such as the NYSE, instead of being directly purchased from the issuing company, like mutual funds.   Exchange traded funds offer a very easy way to diversify a small investment and they have many benefits over mutual fund investing.

Benefits of Exchange Traded Funds vs. Mutual Funds

  • There is no minimum investment other than the market price of one share for ETFs.  Mutual funds often have a minimum of investment of $2,500 making portfolio diversification difficult for new investors.
  • Exchange traded funds typically have lower fees than traditional mutual funds. There is no redemption fee required at liquidation and the commission charged to buy or sell stock is similar to that of a stock trade.  Index funds are also no-load and are commission free.
  • Tax efficient.  The structure of exchange traded funds gives the investor a tax advantage over mutual funds.  Since they are traded on an exchange, the ETF investor sells to other investors and there is no underlying security that is sold. There are also no capital gains that are distributed.  Mutual funds however, must sell underlying securities upon redemption, and the capital gains are distributed to the owners of the funds.  This can result in taxable gains and losses that are passed on to the investor when investing in mutual funds.
  • Faster liquidation of a position for exchange traded funds.  They also allow the ability to set a limit order allowing for flexibly trading that a mutual fund could not offer. They can also be more liquid that the individual shares that they hold and more specifically for an ETF that holds small cap stocks that are thinly traded, or bonds other than U.S. Treasuries.
  • Pricing. The purchase and selling of exchange traded funds happen at market prices instead of end-of-day net asset value, used by mutual funds. They can be continuously priced throughout the day allowing the investor to react to open market conditions on an intraday basis. As result an ETF can be purchased at a premium or at a discount to the value of the underlying assets

Exchange traded funds provide small investors with more choices and they also force the investor to conduct more research on markets that they previously had no experience in. They also enable those individuals who are working to build a strong portfolio through diversification, to invest smaller amounts of money at first.  If you are interested in ETFs continue to do research and learn about the ins and outs of investing in these types of funds.

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