Investing in Exchange Traded Funds

Exchange traded funds (ETFs) are open-ended funds that trade on stock exchanges. Unlike an actively-managed fund, an ETF is usually tied to an index. Because they rely on index-tracking rather than active management, the fees for ETFs are typically a fraction of those for actively-managed funds. The overall investment with ETFs can be much less than if you were to purchase all of the stocks separately, yet you can achieve the same return.

ETFs are most often set up by large investment companies that purchase a basket of securities to reflect a particular index. They then sell portions of the basket to investors in the form of shares. The investment company will keep the ETF in tune with any changes that are made to the underlying index, so the performance of the ETF will mirror that of the index. In recent years, there have been a growing number of actively-managed ETFs introduced, but one of the major benefits of ETFs- low overhead- is lost with these packages.

Index ETFs
These very traditional ETFs track the performance of broad indices, like the S&P 500. Some of the better-known index ETFs include the DIA, which tracks the performance of the Dow Jones Industrial Average (DJIA) and the “cubes” (QQQQ) which tracks the NASDAQ 100.

Sector ETFs
These ETFs are constructed to mimic the performance of specific industry segments, like financials, technology, transportation, etc. Investors choose sector-based ETFs when they believe a specific sector or industry will perform well over a period of time.

Commodity ETFs
Commodity ETFs invest in commodities, such as agricultural goods, natural resources and precious metals. These ETFs can focus on a single commodity by storing it or investing in futures contracts. Commodity ETFs may also track the performance of a commodity index to include many individual commodities.

Style ETFs
Style ETFs are can be divided by the size of the stocks and let you choose between stocks emphasizing growth or value approaches.

For many investors without the time or inclination to conduct detailed stock research and analysis, ETFs can make sense. Low management fees, instant diversification, and wide selection are often cited as the major benefits of ETF investing. Newer investors often leverage ETFs as a starting point, narrowing down their investing interest to a specific market segment tracked by an ETF. As the investor grows in experience, they may start to incorporate more individual securities into their portfolio.

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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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