An ETF, or exchange-traded fund is a mutual fund that is traded on a stock exchange and it has been around since the 1990’s. These days, ETFs are becoming exceedingly popular, with more and more people jumping onto the investment bandwagon in order to expand their financial portfolios with the assistance of these financial products. According to the Motley Fool staff;
The combination of index investing with the handiness – and lower costs – of individual stock ownership is irresistible.
Getting to know a bit more about these options is something that every investor should do; those that aren’t sure why they need to familiarize themselves with these funds should take the time to find out why they are making a big mistake ignoring the basics.
The Basics of ETFs
The flexibility of ETFs is one of the reasons why these options are so popular today. As well as being a valuable asset to a financial portfolio, the nature of these investments makes them appealing to both the professionals and the novices within the market. While there are those that don’t believe in keeping all of their eggs in one basket, some people choose to focus solely on these funds when attempting to build on their portfolios, which goes a long way in highlighting their popularity. Investors shouldn’t simply assume that they’ll have an easy time when they go about picking this specific financial option, however.
According to Ken Hawkins, founder of Ohow Investor Consultants;
…as with any other investment vehicle, in order to truly benefit from ETFs, investors have to understand and use them appropriately.
This means that investors should see them as quick solutions that pose minimal risk and fair rewards; they should be taken seriously, just as any other investment is. This doesn’t mean that they are difficult to understand, however, as most experts will quickly explain, but there are certain pros and cons that will affect just how much someone gets out of their investment, if anything at all. Blindly making any investment is never a good idea; this is something that an investor should keep in mind whether they are investing only a couple hundred dollars or whether they are considering putting a large piece of their financial portfolio at risk.
ETFs and Mutual Funds
Most people are aware that ETFs and mutual funds are similar in nature, although there seems to be some confusion about these similarities and differences.
As Hawkins puts it;
An ETF trades like a stock on a stock exchange and looks like a mutual fund.
While the similarities are marked, there are also many differences between the two. The ETFs might be designed to track indexes, but they are actually managed in a very passive way; this is different from mutual funds, which tend to be managed very actively. This is only one of the many differences in which people approach these two investment opportunities; although these differences aren’t carved in stone.
The Rise of the ETF
While ETFs and mutual funds might look similar in certain ways, ETFs are actually quite new to the market, when compared with their mutual fund counterparts. It was the State Street Global Advisors who introduced the ETF onto the market, although they quickly rose in popularity. By 2007, it is estimated that there were about $800 billion worth of ETFs on the market.
Each ETF represents shares in a unit investment trust, or UIT, and these hold bonds, stocks or commodities. Many of the goals of ETFs are the same as mutual funds; one, for example, aims to pool the assets of managers and investors so that the money can be invested with very specific and structured goals in mind.
It should be noted, however, that the redemption and creation process for ETF and mutual shares differs quite substantially; while the latter involves sending money to a company that will then use it to purchase shares or securities, ETFs do not revolve around cash when it comes to their creation.
Active VS Passive Investing
Those that want to take ETF investing to the next step might want to consider actively managing this facet of their portfolios, because, according to Abram Brown of Forbes;
Actively managed exchange-traded and mutual funds have recorded positive outflows in just 13 of the past 72 months.
The debate over passive vs. active investments has been raging for years now, and yet it seems that the latter is steadily gaining ground. Debates like this do beg the question, however; “is one really better than the other?” Many of the experts are stating that individuals shouldn’t consider one over the other; rather, they should attempt to incorporate both into their portfolios. The director of mutual fund research for Morningstar, Russ Kinnel, states that;
If you can use both together, that’s going to work out pretty well for you.
As with every debate, there are always two sides to a story. According to the New York Stock Exchange, there are a few benefits of taking advantage of passively managed ETFs, including the fact that it saves on costs related to the management of the funds, as well as the transaction costs. When people are involved in passive management, they tend to stick to the administrative duties, such as implementing share splits, processing dividends and ensuring that that the portfolio and the reference index correspond, making it a much simpler task to undertake, and therefore much more appealing to those just entering this field.
ETF investments, just like with any other investment options, comes in a wide range of shapes and sizes, and so they are able to benefit different types of investors. It is important to keep in mind, however, that a considerable amount of time and effort needs to go into any decision to purchase a financial product, whether it involves an active or a passive management approach. Ultimately, it is only information that will assist an investor in determining whether ETFs are right for them, so it’s up to you to get studying.
