ETF Basics
It has been consistently demonstrated that your investment returns aren't so much a function of what stocks your invested in, but what sectors/asset classes your invested in. In the dot com boom, it didn't matter what dot com stock you invested in, if you were invested in dot com companies, you probably did alright. During the dot com bust, it wasn't just a couple select companies that went down, it was just about all of them. Because of this tendency for similar stocks to move together, it is much more productive to be able to simply buy " or short - a type of stock, then try and nail the exact right company. But how can you gain exposure to a sector without taking unnecessary risk based on the company?
The answer lies in a little tool known as the ETF. ETF stands for Exchange Traded fund. Think of it as a mutual fund that isn't actively managed, focuses on a certain area, and can be traded like a stock without incurring extra penalties. Each ETF holds a number of companies, similar to a mutual fund, and its listed price is simply the overall value of the companies it holds.
Each ETF is designed to mimic an investment in a certain industry, region, or type of stock. Some examples of ETFs are the XLI, XLU, and EWC. These ETFs grant an investor exposure to the industrial sector of the S&P 500, the utilities sector of the S&P 500, and the entire Canadian stock market, respectively. Similarly, one who simply wanted to match the S&P 500 indexs returns could just invest in the SPY.
Yet if ETFs are so similar to mutual funds, why not just use a mutual fund. There really are a couple reasons to do so. First off, mutual funds have a history of underperforming the stock market as a whole after fees are included. This makes simple index investing, through an ETF representing a large basket of stocks, such as the SPY, an extremely effective way of matching the markets returns with nearly no cost. There are also slight tax advantages with ETFs compared to mutual funds. Mutual funds have to pay capital gains tax whenever they sell one of their holdings, and whenever they have a large wave of redemptions, they have to sell their positions to come up with the money. This leads to excess fees, some of which get passed on to the remaining investors.
Of course, the vast convenience ETFs have over mutual funds shouldn't be underestimated. ETFs can be traded just like a stock, giving active traders the ability to buy and sell intraday. The ability to short was impossible with a mutual fund, but now it can be done. During any bear market, the ability to benefit from the fall of sectors as well as their rise is a valuable one to have.
A great boon to ETF investors, never before experienced by mutual fund holders, is the ability to use stock options to control risk. Stock options can be used to reduce the risk by using covered calls, or buying protective puts. Alternatively, call options can be used to control maximum loss, and potentially increase profits.
When investing in ETFs, its important to consider how exactly that ETF works. This can usually be found with a quick google search. While most ETFs attain their returns simply by holding the underlying securities, other ETFs use more exotic means to match their benchmark/investment objective, sometimes with varying success. Particularly important is the differentiation between an ETF and an ETN. ETNs are debt based investments, similar to bonds in some ways, and so their value is also partially dependent on the issuer. For this reason, investments in ETNs should be approached with caution, especially in the current, credit-tight market.
The only reason not to use ETFs is a lack of understanding, for they really are one of the most revolutionary investment tools of the 21st century. Their ability to reduce risk through diversification across an asset class, while still effectively giving an investor exposure to an entire sector, should be taken advantage of by everybody, for both long and short plays. ETFs are an invaluable asset for everyone invested in any stock market, and their advantages should be used to the fullest. - 23211
The answer lies in a little tool known as the ETF. ETF stands for Exchange Traded fund. Think of it as a mutual fund that isn't actively managed, focuses on a certain area, and can be traded like a stock without incurring extra penalties. Each ETF holds a number of companies, similar to a mutual fund, and its listed price is simply the overall value of the companies it holds.
Each ETF is designed to mimic an investment in a certain industry, region, or type of stock. Some examples of ETFs are the XLI, XLU, and EWC. These ETFs grant an investor exposure to the industrial sector of the S&P 500, the utilities sector of the S&P 500, and the entire Canadian stock market, respectively. Similarly, one who simply wanted to match the S&P 500 indexs returns could just invest in the SPY.
Yet if ETFs are so similar to mutual funds, why not just use a mutual fund. There really are a couple reasons to do so. First off, mutual funds have a history of underperforming the stock market as a whole after fees are included. This makes simple index investing, through an ETF representing a large basket of stocks, such as the SPY, an extremely effective way of matching the markets returns with nearly no cost. There are also slight tax advantages with ETFs compared to mutual funds. Mutual funds have to pay capital gains tax whenever they sell one of their holdings, and whenever they have a large wave of redemptions, they have to sell their positions to come up with the money. This leads to excess fees, some of which get passed on to the remaining investors.
Of course, the vast convenience ETFs have over mutual funds shouldn't be underestimated. ETFs can be traded just like a stock, giving active traders the ability to buy and sell intraday. The ability to short was impossible with a mutual fund, but now it can be done. During any bear market, the ability to benefit from the fall of sectors as well as their rise is a valuable one to have.
A great boon to ETF investors, never before experienced by mutual fund holders, is the ability to use stock options to control risk. Stock options can be used to reduce the risk by using covered calls, or buying protective puts. Alternatively, call options can be used to control maximum loss, and potentially increase profits.
When investing in ETFs, its important to consider how exactly that ETF works. This can usually be found with a quick google search. While most ETFs attain their returns simply by holding the underlying securities, other ETFs use more exotic means to match their benchmark/investment objective, sometimes with varying success. Particularly important is the differentiation between an ETF and an ETN. ETNs are debt based investments, similar to bonds in some ways, and so their value is also partially dependent on the issuer. For this reason, investments in ETNs should be approached with caution, especially in the current, credit-tight market.
The only reason not to use ETFs is a lack of understanding, for they really are one of the most revolutionary investment tools of the 21st century. Their ability to reduce risk through diversification across an asset class, while still effectively giving an investor exposure to an entire sector, should be taken advantage of by everybody, for both long and short plays. ETFs are an invaluable asset for everyone invested in any stock market, and their advantages should be used to the fullest. - 23211
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The first step to making money in the markets is learning them, so come to my website and learn the ways of the markets! learn to use important techniques such as ETF Investing, Stock trading strategies, stock options, and more!
posted by X - Men @ 1:39 AM
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