Saturday, March 18, 2006

ETFs or Exchange Traded Funds

ETFs or Exchange Traded Funds

Are you thinking about investing in Exchange Traded Funds currently the darling of the investment world. So exactly what are Exchage Traded Funds or ETFs? ETFs are more like a similar to an index mutual fund however when you buy and sell them they are more like a stock. Each ETF represents a particular group of stocks such as the SPDR or QQQQ.

SPRD example: The investment SPRD seeks to correspond generally to the performance, before fees and expenses, of the S&P 500 Index. SPDR Trust is an exchange-traded fund ETF that holds all of the S&P 500 Index stocks. It is comprised of undivided ownership interests called SPDRs.

QQQQ example: The investment QQQQ ETF is a unit investment trust designed to correspond generally to the performance, before fees and expenses, of the Nasdaq-100 Index. The fund holds all the stocks in the Nasdaq-100 Index, which consists of the largest nonfinancial securities listed on the Nasdaq Stock Market.

What are the advantages to ETFs:
First of all unlike a mutual fund ETFs can be bought and sold any time during the day. Mutual funds only trade at the end of the day closing price. ETFs generally have much lost expense ratios. For example the SPY that we talked about above has an expense ratio of only .1% which is significantly lower than a mutual fund. ETFs are also more tax efficient that mutual funds because there are less capital gains. Mutual funds pass on the capital gains at the end of each year to the investor. With an ETF a significant portion of the capital gain can delayed until the investment is actually sold.

Disadvantages of Exchange Traded Funds: Probably the biggest disadvantage of ETFs are the commissions. Since they are traded like a stock you need to have a brokerage account to buy them and therefore you will pay a commission. ETFs also don't have to trade at a net asset value and potentially could be trade at a higher or lower level than the actual value of the portfolio.

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