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What are ETFs (Exchange Traded Funds)?

Posted By Marcus Holland On Saturday, January 12th, 2013 With 0 Comments

An ETF gives you the ability to invest your money in an entire index of equities rather than buying individual stock from a broker. For example, if you think that the FTSE: LSE as a whole will perform rather well over the next few months, then you may want to consider trading at ETF rather than picking out individual gainers.

There are both advantages to investing in an Exchange Traded Funds including:

Savings on fees 

If you were to purchase stock in fifteen individual companies, it is likely that you will be charged broker fees on each transaction.  With an ETF, you will incur costs on that one trade

Trading Control 

When compared to mutual funds, you will find that there is considerably more trading control with ETFs.  For example, unlike mutual funds, where you can only trades at the end of the working day, ETFs can be traded throughout the day in the same way as an individual stock.

Low Minimum Investment 

It is possible to Invest into an exchange traded fund and purchase just one share, the same as if you were investing into a stock.  Again, if you compare this to a mutual fund where a $X,XXX minimum will be required, it can be seen why ETFs are preferred by many.

ETFs are More Like an Equity Than an Index

Although an ETF will track the ups and downs of an index, you do not need to purchase a number of different equities to make your investment. Much like an equity, you will actually only have to bid for the purchase of one investment product. For example, if you are someone who likes the ideas of famous investor Jim Rogers, then you may want to invest in the equities listed on the Rogers International Commodity Index. Instead of purchasing each individual equity found in that index, you can actually purchase an ETF that will mimic the movements of the entire index. The ETF for this particular index would be Elements Exchange Traded Notes Rogers International Commodity Index – Total Return (RJI).

Other Types of Exchange Traded Funds

In addition to tracking the performance of a particular index with an ETF, you can also track the performance of certain commodities. If you are someone who would like to invest in gold, then you can actually purchase a gold ETF instead of the physical metal. This is one of the preferred methods of investing in many commodities because it makes it easier for the investor to track the investment with the rest of their equities. There are ETFs available for a large number of different commodities, but two of the most popular commodity ETFs are GLD and USO. GLD is an ETF that tracks the price of gold, while USO is the United States Oil Fund.

How ETFs are Unique

Although ETFs have many similarities with entire indexes and single equities, they also have some characteristics that make them rather unique. For example, when you purchase a particular equity, you are usually trying to predict a positive performance for a single company. On the other hand, you are predicting a positive performance for an entire industry or group of companies when you purchase an ETF. This gives investors a great method of betting on the success of many related companies rather than putting all of their eggs in one basket. The obvious benefit of this action is that it adds a bit of extra diversification to one’s portfolio.

The Main Benefits of Using ETFs

There are many advantages to investing in ETFs, and they can be used to hedge yourself against risk, add extra diversification to your portfolio or help yourself invest in an idea rather than a specific company. One of the main benefits of the ETF is that you only have to do one transaction to invest in your vision. If you have an idea about future movements in a certain index, then you can bet on that idea with a single transaction when you use an ETF. This provides a cost-effective way to invest in a number of different equities because most people have to pay a flat fee when they buy or sell anything on the various markets around the world. One of the main benefits of ETFs that most newcomers to the world of investments do now see is related to taxes. While there are definitely taxes involved with the sale of an ETF, you don’t actually have to pay that capital gain tax until the entire ETF has been sold. In other words, you will not have to pay any taxes while you are holding onto the ETF. This is a major advantage over a regular mutual fund because the assets found in a mutual fund are often traded at a rather frequent rate by a manager.

Disadvantages of ETFs

Although there are plenty of advantages to be found when it comes to Exchange Traded Funds, there are also some downfalls. One of the main downfalls with ETFs is that they are not available all over the world. People who wish to invest in foreign countries around the world, especially emerging markets, may find that they are not able to take advantage of their investment strategy with an ETF. Another disadvantage of ETFs is that they usually do not come with a lot of volume during the day. There can be a relatively large gap between the bid and ask price when you go to purchase an ETF. Some people think that ETFs are perfect for day traders, but the fact of the matter is that these kinds of investment products are usually reserved for long term strategies. If you are someone who is trying to make a quick buck, then you may want to steer clear of ETFs because you will have to wait for changes in an entire index rather than just one company.

You Decide How ETFs Fit into Your Portfolio

Now that you have all of the information that you need in regards to Exchange Traded Funds, you can decide whether or not these investment tools will be useful when it comes to your overall investment strategy. As always, make sure that you completely understand the ins and outs of a particular ETF before you put in that buy order.

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