Exchange-traded funds, known as ETFs for short, are investments that are hybrids of mutual funds and individual stocks.
- Similar to mutual funds, ETFs allow investors to own a wide variety of many investments (even different kinds within the ETF) by buying just one investment.
- Similar to stocks, ETFs can be bought and sold anytime throughout the trading day.
ETFs have grown exponentially in popularity and are the fastest-growing segment of the investing industry.
What Are ETFs?
ETFs are individual investments that track the performance of an entire index, (investments grouped together based on certain criteria). There are ETFs with Blue Chip stocks, mid-cap stocks, small company stocks, companies based only in certain countries, based on a manufacturing segment, or any one of hundreds or thousands of other criteria.
An index can contain a group of virtually any type of investment, whether stocks, bonds, or commodities such gold and silver. When you buy an ETF, you own a fractional stake in all of the investments contained in the index that the ETF tracks. For example, if you own shares in an ETF that tracks an index of 1,500 stocks, you’ll own a tiny slice of each one of those stocks. The advantage is that you don’t have to buy the individual stocks themselves.
How Do ETFs Work?
Just like individual stocks, ETFs trade in shares on stock exchanges. Each ETF has a share price that changes throughout the trading day based on the performance of the investments in the index that the ETF tracks. As those investments rise or fall in value, so does the ETF’s share price. To buy or sell an ETF, you need to know its trading symbol and the number of shares that you’d like to buy or sell.
Who Creates and Markets ETFs?
There are thousands of different ETFs on the market, and many more are constantly being created and introduced. About 10 financial services firms dominate the ETF industry, though other firms are quickly catching up. The firms that sell ETFs to the public are known as ETF families. Some of the more common ETF families include:
- FocusShares – now 15 ETFs are COMMISSION FREE through Scottrade
Why Invest in ETFs?
ETFs are a highly effective way for individual investors to invest their money with several advantages over mutual funds and individual stocks. These differences can make ETFs a better choice for many individual investors.
Mutual funds are investments that pool money from many investors and invest it in a specific set of investments, such as a group of individual stocks or bonds. Actively managed mutual funds use fund managers to hand-pick the fund’s investments on an ongoing, “active“ basis. Passively managed funds, also known as index funds, own investments that match those of a market index, just as ETFs do.
Though ETFs and mutual funds both allow investors to own a group of investments by buying just one investment, ETFs have multiple advantages over mutual funds:
- Lower expense ratios in many cases
- No or very low minimum investment requirements
- Trading flexibility
- Tax advantages
- Protection against possible fraud
Take a good look at ETFs. They can be a great addition to your personal portfolio and since they’re so targeted, you can easily diversify within a market segment that suites your personal needs and risk tolerance. Though you can buy ETFs through any discount broker, including Etrade, Zecco, tradeMonster, or TradeKing, only Scottrade now has COMMISSION FREE ETFs available to its customers.