ETF's allow the investor to do more than simply trade during the day like stocks. ETFs can also be sold short or traded on margin. They allow investments in several companies in a common sector with a single purchase, like a mini-mutual fund, but prices change continually during the day like stocks instead of being set once a day like mutual funds.
The Benefits of Investing ETFs as Investments
Like common stocks and bonds, ETFs can be traded during regular trading hours. They provide an opportunity for speculative investors to bet on the direction of shorter-term market movements through the trading of a single security. For example, if the S&P 500 has a steep rise in the price of home building stocks through the day, investors can take advantage of it by purchasing a home building ETF, hold it briefly while the price continues to rise and then sell it at a profit before closing.
Since stocks of particular sectors tend to move together, a buyer may not have to spend time researching the best single equity and instead purchase an ETF based on a rising sector. This gives the investor ownership of perhaps several dozen companies that have been picked by experts in that sector.
Some ETFs focus on a variety of equities with similar sectors like health, financials, mining, etc. For investors who trade want bonds in their portfolio there are bond ETFs. Pretty much every investment vehicle regularly traded is available in one of hundreds of ETFs which can be purchased and sold just like stocks.
An investor can diversify with $5,000 by purchasing an ETF that is based on a variety of emerging market stocks. The single fund portfolio might contain forty emerging market stocks that represent financials, energy, consumer goods, technology, etc. Buying the same stocks individually would incur high commissions, which are avoided with ETFs.
Low Expense Ratios Compared to Mutual Funds
ETFs carry and expense fee in addition to commissions. It is wise to compare fees of mutual funds with ETFs since fees may be similar. Investors should study expense fees for ETFs before investing just as they would study any investment.
Specifics about exchange traded funds and mutual funds are available on numerous websites like Morningstar and The Street, as well as online trading sites.
Online ETF Trading offers Convenience
ETFs can be traded through online trading sites as conveniently as equities. Also, since online stock trading sites offer very low commissions the ETF fees can be offset by the low trading fees. Nevertheless, some advisors recommend that ETFs be held longer to make up fees. Like individual stocks, fees and commissions can eat away at profits especially when the investor is inclined to be speculative.
Online trading sites typically offer good information to evaluate ETFs just as they offer on stocks. A buyer might want to study the particular stocks, bonds, REITs, etc. that are included in a particular ETF before buying. Investing in ETFs is not a sure thing. The stock markets always carry risks.
Diversification is an Important Investment Consideration
Diversification in ETFs is important just as in securities. ETFs are an easy way to create a diversified portfolio since many are internally diverse within a sector. Hundreds of ETFs are available covering every major index and sector of the equities market including large cap, small cap, and mid cap stocks.
While ETFs offer fewer choices in the fixed-income arena, there are still plenty of options, including ETFs composed of long-term bonds, mid-term bonds and short-term bonds. While fixed-income ETFs are often selected for the income produced by their dividends, some equity ETFs also pay dividends.
Risk management is an important factor responsible in investing, and ETFs are a convenient way for investors to build a portfolio that manages risks. Bond ETS can be purchased to offset the risk of securities by purchasing a desired percent of equity or sector ETFs. Since ETFs involve dozens of investments, diversification is broader.
The costs of ETFs are suitably low and the portfolios are flexible and easily diversified. ETF investments are as easy as buying stocks, but have the advantages of the broader investment strategies of mutual funds. Although there are small additional fees, they are less than mutual funds. Online ETF trading is as simple as buying securities and funds are available in virtually all investment areas of interest to the typical investor.
Sources:
- “Active and Passive ETF Investing,” investopedia.com (Accessed November 9, 2010)
- “Exchange-Traded Funds,” fool.com (Accessed: November 11, 2010)
Harvey Craft - I am a retired educator with diverse experience. I read anything science, education, and history. I write to share what I learn.
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