ETF Trading Basics

January 14th at 1:56pm by Tom Lydon

Instead of painstakingly selecting single stocks to craft a portfolio, investors can diversify their investments with easy-to-trade, low-cost exchange traded funds.

ETFs are a type of investment fund that trade on stock exchanges, like stocks, writes John Persinos for Investing Daily. [4 Common ETF Questions Answered]

Most ETFs passively track a benchmark index, such as the Standard & Poor’s 500, Dow Jones Industrial or Nasdaq Composite, diversifying your money across hundreds, if not thousands, of stocks. These ETFs will only change their holdings when the underlying index makes changes. [ETF Basics]

Research has shown that the average investor earns less than the market average as people unsuccessfully try to play and beat the market. With a passive index-based ETF, you stick to market moves.

Investors pay low management fees with ETFs, compared to traditional mutual funds. As passive products, ETFs typically only have to reflect the performance of a benchmark, so there is no need to pay a team of active managers.

Moreover, some may also find that brokerage platforms offer commission-free trades on select ETFs. [Six Popular Commission-Free ETF Trading Platforms]

Since ETFs trade like stocks, an investor can execute stock-like trades with ETFs, such as stop-loss, limit or short sale orders.

ETFs track a variety of benchmarks and assets, including equities, fixed-income, commodities and currencies. The funds can also be broken down into sectors and sub-sectors. Since no two ETFs are created alike, investors will have to look at a fund’s holdings when comparing ETFs that cover the same investment theme.

Discouraged by underperformance in actively managed mutual funds, more investors are turning to passive index-based ETFs. ETFs made up 13.2% of fund industry assets by the end of 2013, compared to 12.7% for 2012. According to a recent Charles Schwab survey, 50% of respondents are seeking to increase ETF holdings over the next year, compared to 41% of 2012 respondents.

There are 1,542 U.S.-listed ETFs on the market, with almost $1.7 trillion in assets under management.

For more information on ETFs, visit our ETF 101 category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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