What is an ETF?

WHAT O AN ETF? If you spend any time reading up on the stock market, the economy, or personal finance, chances are that you have heard about the exchange-traded fund (ETF). It's not a traditional stock, and its not a mutual fund- so, what exactly is it? We examine the short, but illustrious, history of the ETF and why it can be a useful investment. THE ETF EXPLAINED An ETF is a security that tracks the value of an index, commodity, or basket of assets in the same way as a mutual fund does, except it trades like stock on stock exchanges. ETF stands for Exchange-Traded Fund EXCHANGE TRADED FUND They are bought and sold on a stock exchange, like the New York Stock Exchange. They can be traded like a stock. Just like a mutual fund, they track the valuation of an index, commodity, or basket of assets instead of a single stock. How Are ETFS Bought and Sold? $5,000 Jane has $5,000 dollars she would like to invest. Jane likes to trade stocks on her own Jane has been hearing about ETFS and starts doing some research. through her online broker. BULLION MINERS Jane learns about how well gold is performing and looks up some of the popular ETFS associated with gold. Jane decides that it would be good to have exposure to two different sides of the gold market: Bullion and miners. Jane likes this because she doesn't need to have the physical gold in her possession to own it, and she wants to invest in multiple gold miners because it is less risky than investing in just one. Jane purchases shares of GLD (a gold bullion ETF) and GDX (gold miners ETF) through her online broker. She now monitors these investments closely each day. THE ETF EXPLOSION Since the inception of the first (surviving) ETF in 1993, Standard & Poor's Depositary Receipts (SPDR), their popularity as an investment tool has soared. Number of ETFS by year ETFS currently on the market allow you to invest in: 1993 1997 19 2001 102 2005 204 2009 819 32 COUNTRIES 16 COMMODITIES 2010 967 2011* 1,163 Total Assets Under Management as of $1.07 Trillion October 31, 2011 14 CURRENCIES 30 DIFFERENT PARTS OF THE BOND MARKETS *as of October 31 Top 10 Largest ETFS by value of assets: In millions US$ as of October 2011 $90,880 $68,825 $46,291 $38,136 $35,082 $27,421 $25,399 $21,321 $19,071 $17,019 SPER S&P 500 Vanguard MSCI total SPDR Gold Vanguard MSCI iShares IShares MSCI- İShares Power İShares iShares Emerging Markets MSCI-EAFE Emerging Markets S&P 500 Shares QQQ Barclays Russel Market 2000 HOW ARE ETFS DIFFERENT THAN MUTUAL FUNDS? An ETF's price changes throughout the day, like a stock as it is bought and sold, while a mutual fund calculates its net asset value (NAV) each day. (NAV represents the total value of a mutual fund's assets minus their liabilities.) ETFS are (mostly) passively managed, meaning there is no fund manager attempting to buy or sell stocks that will make the ETF perform better. An ETF's value is determined by how well the underlying asset performs, not a fund manager. Because EFTS are passively managed, the associated fees with owning an ETF are cheaper than a mutual fund. To buy an ETF, you are only required to pay a broker fee for each trade, costing you around $8. Mutual funds, in general, charge hefty fees for the same activity. According to Morningstar research, the average mutual fund has annual expenses of 1.23 percent, while an ETF pays only 0.55 percent. WHY ARE ETFS SO POPULAR? They allow investors to diversify their investments without having to buy mutual funds or a large number of individual stocks. They can be sold short (a method for capitalizing on a security that loses value). They can be bought on margin (purchased with borrowed money). 4 5 Investors can own commodities, such as precious metals and oil, without having to keep them in their physical possession. They have tax advantages that mutual funds do not have. For example, the investor is in control of any capital gains that might be incurred on their profits because they are only taxed when shares are sold. With mutual funds, investors face capital gains whenever fund managers sell holdings at a profit, no matter what the reason. There is an ETF for every investor. Types of ETFS range from simple, single commodities, like gold, to highly sophisticated investing instruments. BUYER BEWARE Investors must be cautious when purchasing ETFS because: ETF ETF ETF Some ETFS are called "synthetic" because they only mimic the behavior of an ETF by utilizing sophisticated derivatives, such as swaps. These funds are more complicated and highly leveraged, using complex and arguably risky methods, like short-selling, to increase returns. Unwary investors will lose their shirt if they don't understand what they're buying. Some experts have concerns that in the event of a market crash, investors who have money invested in ETFS (especially the synthetic, highly leveraged ETFS) will have a hard time liquidating their Different ETFS have different investment goals. Investors should do research and consult a financial expert to determine if buying a specific ETF is a wise investment. assets. SOURCES: FINANCE.YAHOO.COM, CNBC.COM, ICI.ORG, BANKRATE.COM, INVESTOPEDIA.COM, NSX.COM mintcom