Exchange Traded Funds, or ETFs, are investment vehicles that allow investors to buy and sell a basket of securities in a single transaction on an exchange, similar to stocks. ETFs offer a convenient and cost-effective way to gain exposure to a wide range of asset classes, including stocks, bonds, commodities, and currencies.
The History of ETFs
The first ETF, the Toronto Index Participation Shares, was launched on the Toronto Stock Exchange in 1990. In 1992, the American Stock Exchange (Amex) used the Securities and Exchange Commission’s (SEC) “Super Trust Order” to create the first authorized stand-alone index based ETF. However, it wasn’t until the launch of the SPDR S&P 500 ETF in 1993 that ETFs gained widespread popularity in the United States. Since then, the ETF industry has grown rapidly, with more than $6 trillion in assets under management globally as of 2021.
ETFs Today
ETFs have become increasingly popular among investors due to their low fees, transparency, and liquidity. ETFs also offer a wide range of investment options, from broad-based index funds to niche sectors and specialized strategies. ETF Investing is as popular as ever, with over 180 being traded on the Amex today. However, the most popular ETF in terms of assets is still the original S&P-500 Index Fund SPDRs (SPY), followed by the iShares MSCI EAFE Global Index Fund (EFA) and the NASDAQ-100 Index Tracking Stock (QQQQ).
Advantages of ETFs
One of the primary advantages of ETFs is their low cost. ETFs typically have lower expense ratios than mutual funds because they are passively managed and do not require active management. This can lead to significant savings over time, especially for long-term investors.
Another advantage of ETFs is their transparency. Unlike mutual funds, which typically disclose their holdings only on a quarterly basis, ETFs disclose their holdings daily. This allows investors to see exactly what they are investing in and make informed decisions about their investments.
Mutual funds are required to distribute capital gains received from transactions, which results in capital gains taxes for all shareholders. There are no such requirements for ETFs. In addition, when a shareholder chooses to sell his ETF, it will simply be sold in the market to another investor, meaning there will not be any transactions required to adjust the fund’s portfolio to accommodate for the sale, and therefore no capital gains for the fund.
ETFs are also highly liquid, meaning that they can be bought and sold on an exchange at any time during trading hours. This makes ETFs an ideal investment for traders who want to take advantage of short-term market movements or for investors who want to quickly adjust their portfolio allocations.
One of the key advantages of ETFs is their flexibility. They can be bought and sold like individual stocks, and they offer exposure to a wide range of assets and markets. This means that investors can use ETFs to build a well-diversified portfolio that meets their specific investment goals and risk tolerance.
One buy-order effectively spreads your investment into hundreds of stocks. ETFs allow investors to benefit from diversification to reduce risk, while just paying one single stock commission.
Investing in ETFs
Investing in ETFs is relatively easy and can be done through a brokerage account. Investors can buy and sell ETFs on an exchange just like stocks. ETFs can also be held in tax-advantaged accounts, such as individual retirement accounts (IRAs) and 401(k) plans.
- Placing an Order
The process of placing an order for ETFs is exactly the same as those for stocks. Simply go to the stock order entry page, enter the symbol of the ETF you wish to purchase, select the price, shares, conditions, then submit. The order will appear in your order status page in exactly the same way as a stock order would. In fact, some investors might have purchased an ETF thinking that it was a stock. - Dividends, Splits, and Proxies
When the stocks held by the ETF issuer receive a dividend or split, the proceeds are passed along as a dividend paid by the ETF to the ETF shareholders. The ETF issuer takes care of all the proxies it receives, and the fund will issue it’s own proxy to its shareholders to vote on important topics regarding the fund.
One of the key considerations when investing in ETFs is to choose the right ETF that fits your investment goals and risk tolerance. ETFs come in many different types, from broad-based index funds to sector-specific funds and actively managed funds. It’s important to do your research and choose an ETF that aligns with your investment strategy and objectives.
Various Types of ETFs
Here are some of the most common types of ETFs:
Equity ETFs: These ETFs invest in stocks of companies, and can be broad-based, such as the S&P 500 or Nasdaq Composite, or sector-specific, such as healthcare or technology.
Bond ETFs: These ETFs invest in bonds, and can be broad-based, such as the Barclays Aggregate Bond Index, or focused on specific sectors or regions.
Commodity ETFs: These ETFs invest in commodities such as gold, oil, or agriculture products, and can provide exposure to a wide range of asset classes.
Currency ETFs: These ETFs invest in foreign currencies, allowing investors to gain exposure to currency fluctuations and diversify their portfolio.
Actively managed ETFs: Unlike passive ETFs that track an index, actively managed ETFs are managed by a portfolio manager who makes investment decisions based on market conditions and other factors.
Smart Beta ETFs: These ETFs use a rules-based approach to select and weight stocks based on factors such as value, momentum, or quality, with the aim of outperforming traditional index funds.
Conclusion
ETFs have become an increasingly popular investment option for investors due to their low cost, transparency, liquidity, and wide range of investment options. Overall, ETFs can be a useful tool for investors looking to build a diversified portfolio. However, it is important for investors to carefully consider their investment goals, risk tolerance, and the potential risks and costs associated with any particular ETF before investing.
