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Investing 101: The Exchange Traded Fund (ETF)

30 March 2009 3 Comments

One of the hottest investment products / vehicles over the last few years is the Exchange Traded Fund or the ETF.  What are ETFs?  Should you use them to invest?  I will cover all of the basics here, so you can make an informed decision whether or not to add ETFs to your investment portfolio.

ETFs have gotten very popular because of the following features:

  • It is an easy way to diversify
  • They are typically lower in fees when compared to Mutual Funds
  • You can buy or sell them very easy (just like any stock)

The ETF was created to closely resemble a mutual fund.  It typically contains a basket of stocks corresponding to the desired objective of the fund.  The main difference is that ETFs trade like stocks, which means you can buy and sell them yourself.

Since ETFs are not actively managed like many mutual funds, the fees associated with them are very low.  However, this does not include fees associated with trading incured from your broker.

What Kind Of ETFs Can You Own?

You can buy an ETF to accomplish a number of objectives.  You can buy an ETF to mimic the performance of the S&P 500 (SPY), an ETF that tracks the Oil & Gas Sector (DIG), an ETF that tracks the price of gold (GLD), an ETF that has exposure to Asia (AIA).  There are other ETFs that focus on dividend yield, like the iShares Dow Jones EPAC Select Dividend ETF (IDV).

Also, the new ETFs are the leveraged and the short ETFs.  For example, the PowerShares Gold Double Long ETN (DGP) seeks performance equal to twice the daily performance of gold.  Or, check out the UltraShort Financials ETF (SKF) which seeks double inverse return of the financial sector – this ETF has been the subject of some controversy over the decimation of bank stocks.  Basically, if you think bank stocks will take another huge hit, buy the SKF.

Something to consider with the short/leveraged ETFs is that the performance does not correlate exactly how you might expect sometimes.  Their behavior can by funky since they are using complex financial instruments to mimic some specific desired behavior.  Unless you fully understand the ETF, I’d avoid this group of ETFs.

What Is Inside My ETF?

If you are attempting to achieve diversification or your objective is to have a simple method of holding a group of stocks, ETFs are a great option.  For example, if you want major diversification and/or want to track the overall stock market, buy an ETF that tracks the S&P 500 (also known as Index Funds).

If you want to see the stocks that are held by the ETF, check out the holdings through Yahoo! Finance.  Here are some examples:

Overall, ETFs are a great tool for investing.  I use them, and currently hold several in my personal portfolio.  If you want to take advantage of a macro trend or gain exposure to a specific sector such as energy, yet lack the ability or desire to research specific companies, an ETF might be the way to go.

What ETFs do you invest in?  Add your comments below.

3 Comments »

  • Zeke2040 said:

    Good information. I like to day trade and swing trade with the triple leveraged ETF’s such as FAS and FAZ. Can be risky, but you often see a lot of volatility which is great for day trading.

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