ETF (Exchange-Traded Fund)
List of ETFs (Exchange-Traded Funds)
Exchange-Traded Funds (or ETFs) are a type of closed-end mutual fund.
Essentially, ETFs are mutual funds that trade on the stock market. As such,
they offer features of a mutual fund in a stock-like instrument.
Just like mutual funds, ETFs represent a collection of underlying securities
or stocks. Typically, ETFs try to replicate an index such as the S&P 500,
Dow Jones Industrial Average (DJIA), Russell 2000, MSCI EAFE, and so on.
Presently, nearly all ETFs are passively managed. That is, unlike many
mutual funds, the firm managing the ETF does not actively add or remove
stocks (unless the index being tracked changes). Popular ETFs have names
such as "spiders" (after the ticker symbol SPY), "qubes" (QQQ), or
"diamonds" (DIA). One of the most heavily traded ETFs in the United States
are the "qubes," which tracks the NASDAQ 100.
There are over a hundred ETFs traded on U.S. stock exchanges, with more in
other countries. ETFs have been gaining popularity ever since they were
introduced in the mid 1990s. ETFs are attractive to investors because they
offer the diversification of mutual funds with the features of a stock. The
popularity will only increase as new and more innovative ETFs are
ETFs vs. (Open-End) Mutual Funds
There are many advantages to ETFs, and these advantages will likely increase
as ETFs are improved. Most ETFs have a lower MER (management expense ratio)
than comparable mutual funds. Mutual funds generally charge 1% to 3% while
ETFs are almost always in the 0.2% to 1% range. Over the long term, these
cost differences can compound into a noticeable difference.
ETFs are also more tax-efficient than mutual funds. Mutual funds can trigger
capital gains when large number of holders redeem their shares. In contrast,
ETFs are not redeemed by holders (instead, holders simply sell their ETF on
the stock market, as you would a stock).
Perhaps the most important, although subtle, benefit of an ETF is the
stock-like features offered. Since ETFs trade on the market, you can carry
out trades similar to a stock. For instance, you can short, use a stop-loss
order, buy on margin, and invest as much money as you want (there is no
minimum investment requirement). Mutual funds do not offer those features.
For example, you cannot place a stop loss order on a mutual fund.
ETFs also have some disadvantages when compared with (open-end) mutual
funds. One such disadvantage stems from the fact that many mutual funds are
actively managed. Mutual fund managers can seek out undervalued and
profitable firms whereas ETFs typically just track an index. (Some studies
have shown that 70% mutual fund managers do not beat a passive index.
However, professional mutual fund managers may be better for small-cap,
foreign, and similar areas).
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