| When people ask for investing advice, ETFs usually | | | | generally allow for liquidation of a position faster than a |
| come up pretty quickly, because they are so heavily | | | | mutual fund, which must be liquidated at end of day. |
| marketed and trumped by the industry. | | | | Further, the ability to set a limit order allows flexible |
| Exchange-traded funds, or ETFs, are an easy way to | | | | trading that no investor could get from a mutual fund. |
| diversify a small investment, but to get the most out of | | | | Not all ETFs have the same liquidity, however, and it is |
| your investment, it is important to understand how they | | | | important to review trading volumes and the ETF |
| operate. | | | | prospectus to determine whether you are comfortable |
| ETFs are like mutual funds, in that they are a collection | | | | with the frequency of trades. |
| of investments, but they are traded on an exchange, | | | | 4. Intraday Pricing: Because ETFs are traded on active |
| such as the NYSE, instead of purchased directly from | | | | stock exchanges, purchases and sales happen at |
| the issuing company. They also differ in their | | | | market prices, rather than end-of-day Net Asset |
| redemption structure and tax efficiency from traditional | | | | Value, which mutual funds use. As a result, one may |
| mutual funds. | | | | purchase ETFs at a premium or a discount to the |
| Here are five benefits of ETFs over mutual funds: | | | | value of the underlying assets, and arbitrage is |
| 1. Tax Efficiency: Upon redemption, mutual funds must | | | | frequent. |
| sell its underlying securities, and the capital gains are | | | | 5. No Minimum Investment: When starting investing, |
| then distributed to the owners of the funds. Since | | | | diversification can be cost prohibitive if you're using |
| ETFs trade on an exchange and investors are selling | | | | traditional mutual funds, which frequently have a |
| to other investors, no underlying securities are sold, and | | | | minimum investment of $2500 or more. Because ETFs |
| no capital gains are distributed. If the makeup of the | | | | have no minimum investment (other than the market |
| ETF changes it will, occasionally have to distribute | | | | price of one share), they are a good vehicle for |
| gains, but it should be less frequent than with traditional | | | | diversified investing. |
| mutual funds. | | | | Of course, many of these benefits could be liabilities if |
| 2. Lower Fees: ETFs are no-load funds, and you won't | | | | not used properly. For instance, the intraday pricing |
| be slapped with a redemption fee when it's time to | | | | feature of ETFs could lead an investor to buy an ETF |
| liquidate your position. Further, ETFs typically have | | | | at a premium or sell it at a discount to the value of the |
| lower annual fees than traditional Mutual Funds, making | | | | underlying securities. Also, brokerage fees may have a |
| them an attractive alternative. (NOTE: In rare cases | | | | greater impact on some investors than traditional |
| where a very small amount is being traded, broker's | | | | mutual funds' management fees and loads would |
| fees may be a higher percentage of the investment | | | | have. |
| than a mutual fund's expenses would be, but in most | | | | Used wisely, ETFs can be a good vehicle for widely |
| of these cases the invested amount would not meet | | | | diversifying a small or initial investment, but it is always |
| the minimum investment required by most mutual | | | | best to seek professional investing advice. |
| funds). | | | | In the future I will cover the five negatives of investing |
| 3. Liquidity: The exchange-traded structure of ETFs | | | | in ETFs. |