If you’re just now getting acquainted with exchange traded funds (ETFs), you’re probably wondering what makes them different and better than other investment tools out there. ETFs are similar to mutual funds, in that they’re generally baskets of stocks. But that’s pretty much where the similarities end. ETFs are better. Why? Two of the major reasons are that they trade throughout the day, and they’re completely transparent, meaning, you know what shares the fund holds at any given time. (How to use ETFs in a post-buy-and-hold world).
Are you interested yet? James A. McWhinney for Investopedia has more information on ETFs, to further convince you:
- 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, however, keep in mind that ETFs trade in brokerage firms and can rack up commission costs.
- 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 (those issued by Dow Jones, S&P, Nasdaq) and sector of the equities market (large-caps, small-caps, growth, value). There are international ETFs, regional ETFs (Europe, Pacific Rim, emerging markets) and country-specific (Japan, Australia, United Kingdom) ETFs. Also, ETFs cover specialty asset classes and fixed income.
- Tax Efficiency. ETFs are more tax efficient than mutual funds, largely because of their low turnover. The unique structure of ETFs enables investors trading large volumes (generally institutional investors) to get in-kind redemptions. This means that an investor trading large volumes of ETFs can redeem them for the shares of stocks that the ETFs track. This arrangement minimizes tax implications for the investor exchanging the ETFs since the investor can defer most taxes until the investment is sold. (More reasons ETFs are better.)
For more stories about ETFs, visit our ETF Education Channel.
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.