ETFs 101
While many investors have an overall outlook, and may be able to accurately predict what will be the next big thing, it is often harder to nail which company will be able to best take advantage of the coming conditions. After all, while it may be easy to figure out, retail stocks are going to be hammered by this recession, that doesn't help you decide which retail company is best to short. And while it may be easy to figure out, reduced demand from the developed world is going to hurt Chinese companies, its much harder " especially for those non-mandarin speaking people such as myself " to figure out exactly which Chinese companies might escape this fate. So how can we take advantage of these outlooks without having to pick specific companies?
Exchange Traded Funds are the answer. Exchange traded funds (ETFs) allow you to invest in a group of companies all at once, similar to a mutual fund. The difference is that ETFs are traded directly on a stock exchange just like a stock, they can be bought and sold any time during the day without penalty, and they are both shortable, and optionable allowing you to take advantage of both up, and down moves in the market.
Each ETF is designed to mimic an investment in a certain industry, region, or type of stock. Some examples of ETFs are the XLI, XLU, and EWC. These ETFs grant an investor exposure to the industrial sector of the S&P 500, the utilities sector of the S&P 500, and the entire Canadian stock market, respectively. Similarly, one who simply wanted to match the S&P 500 indexs returns could just invest in the SPY.
Yet if ETFs are so similar to mutual funds, why not just use a mutual fund. There really are a couple reasons to do so. First off, mutual funds have a history of underperforming the stock market as a whole after fees are included. This makes simple index investing, through an ETF representing a large basket of stocks, such as the SPY, an extremely effective way of matching the markets returns with nearly no cost. There are also slight tax advantages with ETFs compared to mutual funds. Mutual funds have to pay capital gains tax whenever they sell one of their holdings, and whenever they have a large wave of redemptions, they have to sell their positions to come up with the money. This leads to excess fees, some of which get passed on to the remaining investors.
Perhaps the biggest consideration is the simple convenience of owning ETFs when compared to mutual funds. They can be bought and sold (or shorted) any time during the trading day, using the same order types available to normal stocks. Free from redemption fees, the only deterrent from actively trading an ETF is belief in the efficient market hypothesis, and the standard commission costs from buying and selling stocks
A great boon to ETF investors, never before experienced by mutual fund holders, is the ability to use stock options to control risk. Stock options can be used to reduce the risk by using covered calls, or buying protective puts. Alternatively, call options can be used to control maximum loss, and potentially increase profits.
One thing to note is that not all ETFs are created equal. While some simply hold a basket of stocks and use those to keep the ETFs value near the benchmark, many use other, more exotic strategies, with various degrees of success. QLD for instance, aims to gain roughly twice the daily returns of the Nasdaq composite index, and is usually fairly consistent when doing this. Another similar instrument is the ETN, which is actually a debt based instrument. While ETNs also aims to gain returns based on a given benchmark, there price is also sensitive to changes in the debt rating of the issuer, and this should be considered when investing in them.
ETFs are a diverse tool that allows one to remove risk from ones portfolio by investing in sectors instead of individual companies. They allow investors to benefit from downturns in markets as well as the uptrends. And they allow the investor to take advantage of options on sectors, which options-savvy investors can use to supercharge returns. Given their great variety of uses, ETFs should be a valued part of any investors portfolio, to be ignored at the investors peril. - 23222
Exchange Traded Funds are the answer. Exchange traded funds (ETFs) allow you to invest in a group of companies all at once, similar to a mutual fund. The difference is that ETFs are traded directly on a stock exchange just like a stock, they can be bought and sold any time during the day without penalty, and they are both shortable, and optionable allowing you to take advantage of both up, and down moves in the market.
Each ETF is designed to mimic an investment in a certain industry, region, or type of stock. Some examples of ETFs are the XLI, XLU, and EWC. These ETFs grant an investor exposure to the industrial sector of the S&P 500, the utilities sector of the S&P 500, and the entire Canadian stock market, respectively. Similarly, one who simply wanted to match the S&P 500 indexs returns could just invest in the SPY.
Yet if ETFs are so similar to mutual funds, why not just use a mutual fund. There really are a couple reasons to do so. First off, mutual funds have a history of underperforming the stock market as a whole after fees are included. This makes simple index investing, through an ETF representing a large basket of stocks, such as the SPY, an extremely effective way of matching the markets returns with nearly no cost. There are also slight tax advantages with ETFs compared to mutual funds. Mutual funds have to pay capital gains tax whenever they sell one of their holdings, and whenever they have a large wave of redemptions, they have to sell their positions to come up with the money. This leads to excess fees, some of which get passed on to the remaining investors.
Perhaps the biggest consideration is the simple convenience of owning ETFs when compared to mutual funds. They can be bought and sold (or shorted) any time during the trading day, using the same order types available to normal stocks. Free from redemption fees, the only deterrent from actively trading an ETF is belief in the efficient market hypothesis, and the standard commission costs from buying and selling stocks
A great boon to ETF investors, never before experienced by mutual fund holders, is the ability to use stock options to control risk. Stock options can be used to reduce the risk by using covered calls, or buying protective puts. Alternatively, call options can be used to control maximum loss, and potentially increase profits.
One thing to note is that not all ETFs are created equal. While some simply hold a basket of stocks and use those to keep the ETFs value near the benchmark, many use other, more exotic strategies, with various degrees of success. QLD for instance, aims to gain roughly twice the daily returns of the Nasdaq composite index, and is usually fairly consistent when doing this. Another similar instrument is the ETN, which is actually a debt based instrument. While ETNs also aims to gain returns based on a given benchmark, there price is also sensitive to changes in the debt rating of the issuer, and this should be considered when investing in them.
ETFs are a diverse tool that allows one to remove risk from ones portfolio by investing in sectors instead of individual companies. They allow investors to benefit from downturns in markets as well as the uptrends. And they allow the investor to take advantage of options on sectors, which options-savvy investors can use to supercharge returns. Given their great variety of uses, ETFs should be a valued part of any investors portfolio, to be ignored at the investors peril. - 23222
About the Author:
You must learn the ways of the market before you can truly succeed there, so visit my website and become a master of the markets! Come and master "insider secrets" such as ETF Investing, stock option strategies, sector rotation, and shorting stock! Release the true power of Exchange Traded Funds in your portfolio, and allow your portfolio to be the best it can be
posted by X - Men @ 3:23 PM
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