Overview of Exchange-Traded Funds (ETFs)

In this section, we cover basics of ETFs. Every investor should know about these low-cost investment vehicles and the possibilities they offer.

With ETFs it is possible to invest domestically and internationally in various asset classes

Exchange-Traded Funds, also known as ETFs, are a response to closed-end funds. ETFs also trade on the exchange and are also a low-cost alternative to regular mutual funds.

The Exchange Traded Funds are based on a variety of indices, whether these are market, country, or industry indices, effectively resembling the Index Funds. ETFs can be purchased like shares via a brokerage account. Since these vehicles trade like stocks, the Net Asset Value of ETFs can be different from their market value. However, any differences are quickly mitigated by arbitrage, which consists of buying underpriced assets and selling overpriced priced ones until there is no difference between the market price and the Net Asset Value.

Investing in Exchange Traded funds is available to investors worldwide. Thus, investors in the US, UK, Australia, Canada, and many other countries can purchase ETF shares. One of the most significant advantages of investing in ETFs worldwide is their low cost. Since many ETFs mimic a variety of indices, they are not actively managed, thus reducing management costs. Moreover, the shares of ETFs don't need to be sold and redeemed by the fund (unlike those of mutual funds) since ETFs trade like equities, and that creates another cost advantage which lowers the cost of ownership.

When it comes to investment options, these are tremendous. Some of the most well-known ETFs include Standard and Poor's Depository Receipts  also known as SPDRs (pronounced Spiders). These Exchange Traded Funds are based on the Standard & Poor's indices including the S&P 500 Index. There are also SPDRs which invest in specific sectors  such as Consumer Discretionary, Consumer Staples, Energy, Financial, Health Care, Industrial, Materials, Technology, and Utilities.

Investors can also invest in other asset classes via ETFs including, but not limited to, commodities or bonds. Furthermore, ETF shares can be bought on margin (with money borrowed from the brokerage house) or sold short.

Major ETF Types

There are three major types. The first one is composed of funds that own actual assets. For example, there are precious metals funds that hold physical gold and silver in vaults. Then, there are precious metals ETFs that bet on movements in prices by buying gold and silver futures contracts. And there are equity-based precious metals funds that buy stocks of gold and silver mining companies.

Related articles on this site: