Let’s get back to basics.
Although the U.S. exchange traded fund market has surpassed $1 trillion in assets, many individual investors are unfamiliar with ETFs’ inner workings. Meanwhile, advisors are scrambling to increase their knowledge and understanding of these financial products.
If you’re just getting acquainted with ETFs, big questions may include what makes them different from other investment tools, and their potential advantages relative to traditional mutual funds.
ETFs are similar to mutual funds, in that they’re generally baskets of stocks, bonds or other securities. But that’s pretty much where the similarities end. First, ETFs can be traded during the day, while mutual funds are priced once, at the close. Also, most ETFs disclose their holdings in real time, so investors can see exactly what’s in the portfolio. Many investors like the transparency of ETFs.
Here are some of the other advantages of ETFs:
- Low expense ratios. Who doesn’t like to save money? The less you pay in expense ratios, the more you get to keep. Many ETFs cost a lot less than mutual funds. Investors pay commissions to trade ETFs, but some brokerage houses offer free ETF trading to clients.
- Diversification. ETFs come in handy when investors want to create a diversified portfolio. There are hundreds of ETFs available, and they cover every major index and sector of the equities market. There are international ETFs, regional ETFs and country-specific ETFs. Also, ETFs cover specialty asset classes, bonds, currencies and commodities. Most ETFs track indexes but some are actively managed.
- Tax Efficiency. ETFs are more tax efficient than mutual funds, largely because of their low turnover. The “in kind” creation and redemption of ETF shares also cuts down on capital gains distributions.
For more stories about ETF basics, visit our ETF 101 category.
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.