Exchange Traded Funds

Exchange traded funds, or ETFs serve as a building block to a diverse portfolio. They are a type of investment fund that allows investors to pool their money in a selected basket of securities that are traded on a stock exchange. In this article, we will go over the basics of exchange traded funds.

The Basics

Investors combine money to invest in a group of securities. They are bought or sold through an organized market like the New York Stock Exchange. They typically are passively managed. Since they are traded, they are subject to price changes throughout the day. You can also buy and sell them during the day while the market is open. When trading ETFs you may have to pay an administrative fee and transaction fees required by the SEC. Your share entitles you to dividend payments, capital gains distributions, or other benefits.

Types of ETFs

There are different types of exchange traded funds, usually based on the type of securities they hold. The first is equity ETFs. These invest in various stocks based in a particular industry or index. Next are fixed income ETFs. These invest in bonds like corporate or government. Third are commodity ETFs. Commodity exchange traded funds invest in things like natural resources or precious metals. Lastly, are currency ETFs. These ETFs track a single or group of currencies. They are usually back by bank deposits in a foreign currency.

Benefits

Exchange traded funds come with several benefits. The first being their low cost. With the way they are set up, they generally do not require portfolio managers to care for the fund. For this reason, they are less costly than actively managed mutual funds. The second benefit is diversification. ETFs allow you to invest in a variety of securities verses in an individual company. Lastly, they can offer you some tax efficiency. ETFs generally trade less than mutual funds, because of this they generate fewer taxable transactions.

Drawbacks

As with all investments, there are some drawbacks to ETFs. First, they lack a level of control. This is because you do not have direct control over which securities are in the fund’s portfolio. Second, is overtrading. The ease of trading exchange traded funds may tempt some to make frequent trades instead of implementing a long-term investment strategy. Lastly, is liquidity. Some ETFs may be harder to sell than others, making your investment less liquid.

What to Consider

If you are interested in investing in exchange traded funds, there are a few points you should take into consideration. First, you need to assess your financial goals. Look at the fund’s prospectus to see if its investment strategy is right for your objective. You also need to make sure it aligns with your right tolerance. If it fits your goals and risk tolerance, you will then need to evaluate at least one year of the ETFs performance to ensure it had been meeting its objectives. If everything looks promising, discuss with your financial planner whether you should invest.

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