ETFs 101
It has been consistently demonstrated that your investment returns aren't so much a function of what stocks your invested in, but what sectors/asset classes your invested in. In the dot com boom, it didn't matter what dot com stock you invested in, if you were invested in dot com companies, you probably did alright. During the dot com bust, it wasn't just a couple select companies that went down, it was just about all of them. Because of this tendency for similar stocks to move together, it is much more productive to be able to simply buy " or short - a type of stock, then try and nail the exact right company. But how can you gain exposure to a sector without taking unnecessary risk based on the company?
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.
The purpose of an ETF is to allow an investor to purchase a single equity that represents an investment in a sector. So if an investor is interested in buying financial stocks, they could buy XLF. If they want some small cap goodies, they can choose to buy IWM. For some exposure to the Chinese stock market, they could invest in FXI. Finally, if they simply want to emulate the returns of the S&P 500 index, the SPY has them covered.
But why shun the mutual fund? Why take the new guy over the established king? Lets start with the tax advantage. When mutual funds endure large sell offs, they have to liquidate many positions, some of which are currently at a gain. They then have to pay capital gains on those positions, and this negatively impacts their return. It would be an understatement to say that Mutual funds generally have higher expense ratios in general compared to ETFs. It can sometimes cost as little as 8 dollars to get into an ETF whereas a mutual fund of 20,000 that grows to 60,000 over a 20 year period may have conservatively lost as much as 18,000 to its competent managers.
Another advantage held by ETFs is their great convenience over their mutual counterparts. Many mutual funds have redemptions fees if you exit within 30 days, whereas ETFs aren't plagued by this problem. Also, unlike mutual funds, you can go short an ETF, benefiting from a fall in a sector instead of a rise. ETFs can also be bought and sold any time during the trading day, using limit orders, stop losses, and all the other tools you can use for buying stock.
Another important consideration is that most of the more liquid ETFs are optionable. This means that option-savvy investors can harness the power of stock options to change the risk-reward profile of their positions, and risk-conscious investors can use stratagems such as the covered call and protective put to protect their investment.
There are some disadvantages to ETFs as well. Some ETFs have complex structures that can lead them to deviate from what they are supposed to be tracking. A similar instrument, ETNs, can also easily be mistaken for an ETF, leading to some general confusion about what exactly you are investing in. Yet for those willing to put in the work to learn, ETFs can be a highly profitable venture for the modern day portfolio.
ETFs are a diverse tool that allows one to remove risk from ones portfolio by investing in sectors instead of individual companies. They allow investors to benefit from downturns in markets as well as the uptrends. And they allow the investor to take advantage of options on sectors, which options-savvy investors can use to supercharge returns. Given their great variety of uses, ETFs should be a valued part of any investors portfolio, to be ignored at the investors peril. - 23159
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.
The purpose of an ETF is to allow an investor to purchase a single equity that represents an investment in a sector. So if an investor is interested in buying financial stocks, they could buy XLF. If they want some small cap goodies, they can choose to buy IWM. For some exposure to the Chinese stock market, they could invest in FXI. Finally, if they simply want to emulate the returns of the S&P 500 index, the SPY has them covered.
But why shun the mutual fund? Why take the new guy over the established king? Lets start with the tax advantage. When mutual funds endure large sell offs, they have to liquidate many positions, some of which are currently at a gain. They then have to pay capital gains on those positions, and this negatively impacts their return. It would be an understatement to say that Mutual funds generally have higher expense ratios in general compared to ETFs. It can sometimes cost as little as 8 dollars to get into an ETF whereas a mutual fund of 20,000 that grows to 60,000 over a 20 year period may have conservatively lost as much as 18,000 to its competent managers.
Another advantage held by ETFs is their great convenience over their mutual counterparts. Many mutual funds have redemptions fees if you exit within 30 days, whereas ETFs aren't plagued by this problem. Also, unlike mutual funds, you can go short an ETF, benefiting from a fall in a sector instead of a rise. ETFs can also be bought and sold any time during the trading day, using limit orders, stop losses, and all the other tools you can use for buying stock.
Another important consideration is that most of the more liquid ETFs are optionable. This means that option-savvy investors can harness the power of stock options to change the risk-reward profile of their positions, and risk-conscious investors can use stratagems such as the covered call and protective put to protect their investment.
There are some disadvantages to ETFs as well. Some ETFs have complex structures that can lead them to deviate from what they are supposed to be tracking. A similar instrument, ETNs, can also easily be mistaken for an ETF, leading to some general confusion about what exactly you are investing in. Yet for those willing to put in the work to learn, ETFs can be a highly profitable venture for the modern day portfolio.
ETFs are a diverse tool that allows one to remove risk from ones portfolio by investing in sectors instead of individual companies. They allow investors to benefit from downturns in markets as well as the uptrends. And they allow the investor to take advantage of options on sectors, which options-savvy investors can use to supercharge returns. Given their great variety of uses, ETFs should be a valued part of any investors portfolio, to be ignored at the investors peril. - 23159
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posted by X - Men @ 1:41 AM
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