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What are Exchange-traded funds?

Exchange-traded funds (ETFs) are a financial investment product that is traded on stock exchanges like other financial investment products such as stocks, bonds, options, etc. The difference is that ETFs have varying underlying assets in the form of other financial investment products. These underlying assets can be stocks, bonds, currency, commodities or a combination of these. The trading value of ETFs is that of the net asset value of its underlying assets. As such, a large majority of ETFs are a complete ‘package’ of various stock indices, like the S&P 500, containing only shares that make up a specific index.

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ETFs are a fairly new financial investment product, one that has gained a lot of popularity amongst public investors and brokers, due to their stock-like characteristics, low costs and the tax efficiency associated with trading them. Although initially ETFs were solely index type funds, recently the financial market has seen the introduction of actively-managed ETFs, a feature most mutual funds (link) and hedge funds (link) enjoy, aiming to obtain higher returns on investment through active management by skilled institutions and individuals.

One key difference between ETFs and traditional mutual funds (link) is that unlike mutual funds, shares in an ETF can be bought and sold throughout the trading day on a stock exchange.

The main advantages of ETFs are:

-       Lower costs – ETFs that are not actively managed, thus in essence index funds, have lower costs compared to other investment products that aim to diversify their investments.

-       Diversification – ETFs are a simple method of diversifying your investment or portfolio to negate the risks of volatility. The broad assortment of various index ETFs available makes for a great diversification of your investment portfolio.

-         Tax efficiency – Due to the low turnover of ETFs’ portfolio securities and their inherent feature of not having to sell securities to fulfill investor redemptions, their tax efficiency is much greater than that of other investment products.

-       Trading flexibility – ETFs, unlike mutual funds, can be bought and sold at the current market price at any time of the day, provided its within the working hours of the stock exchange they are traded on. Since they are categorized as publicly traded securities, various hedging strategies can also be applied through the use of short-selling (link), enabling investors to come up with some very intricate and diversified investment designs.

-       Transparency – ETFs, unlike hedge funds and to a certain extent mutual funds, have publically visible portfolios and their price is frequently updated throughout the trading day.

These particular features of exchange-traded funds make them a very powerful and effective method of investment for experienced and new investors alike. They can also be used as long term investments the same way mutual funds are, as well as being attractive to day traders and speculators due to their stock-like characteristics. All in all a great addition to anyone’s investment portfolio.

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Subjects keywords: Exchange-traded funds, ETF, stocks, bonds, currency, commodities. All information about ETFs.