What Are ETFs?

Written by , April 5, 2011

What are ETFsWhat Are ETFs?

If you’ve spent any time over the past few years researching investment options you may have heard about ETFs. ETF stands for Exchange Traded Fund. They’ve gained enormous popularity and have become quite trendy.

As with any trend, it’s important to be cautious before jumping in – particularly when your money is potentially at risk. So let’s first look at what an exchange traded fund is. “Exchange Traded” means that it is traded just like a traditional stock. “Fund” means that it is a collection or group of investments, which can include stocks and bonds.

Generally the investments are grouped by industry or theme. For example, you might find an ETF with various pharmaceutical companies. Like other funds, an ETF is then managed by a financial institution. When you buy an ETF you’re buying an investment, managed by someone else, that may have stock in hundreds or thousands of companies.

What are The Advantages and Disadvantages of ETFs?

  • Active Trading. They’re actively traded throughout the day. Unlike a standard mutual fund, an ETF is traded throughout the day. This means you can buy or sell your ETF whenever the market is open. You don’t have to wait until the end of a trading day like you would with a mutual fund.
  • Low Initial Investment. One of the advantages to an Exchange Traded Fund is that they often have a low initial investment. Where you may need several thousand dollars for a mutual fund or an index fund, you only need to buy a single share of an ETF.
  • Not FDIC Insured. This can be too big of a risk for some investors. If you don’t want to risk losing your money then consider a secured investment.

  • Commissions. When you buy or sell an ETF you will pay a fee to your broker just as if you’d bought or sold a stock.
  • Low Expenses. One of the primary draws for ETFs, besides the low investment, is that they generally have a low expense ratio. The expense ratio is the amount of money taken out of the fund at the end of the year to cover the expense of the fund.
  • Trading Knowledge. Because an ETF is traded, in order to successfully invest, you’ll want to know a bit about trading and how to track your investment on the market. However, if you’re familiar with trading stocks then trading ETFs follows a similar process.
  • Diversification. ETFs can fill a gap in your portfolio. In fact, they’re often used specifically for this purpose. For example, you can invest in a broad market ETF which may have thousands of companies represented in the fund.
  • If you’re interested in pursuing ETFs as an investment option, spend some time reviewing the fund’s information. What’s the past performance of the fund? Who manages it and what is their track record? What are the fees, expense ratio and what is the commission rate for your broker? What securities are represented by the fund and what is the performance of those various companies? Finally, how will an ETF help you diversify your portfolio?

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