What is an Exchange Traded Fund?

What is an Exchange Traded Fund?

By Larry Lane for InvestorZoo.com

Commonly known as ETFs, Exchange Traded Funds have been traded since the mid 1990's. ETFs are a direct competitor to index mutual funds. Like mutual funds, they offer instant diversification, usually tracking an index.

Today ETFs match a wide variety of indexes. There are ETFs to match indices of specific individual countries, individual commodities, bonds and even currencies.

ETFs may have the look and feel of a mutual fund; however ETFs can be traded like a stock in real time. This offers the investor the advantage of being able to buy or sell on a minute by minute basis. Because ETFs are actively traded like a stock, their financial structure is vastly different from a mutual fund.

When a shareholder sells their shares in a mutual fund, the fund manager has to find money to match the redemption. Since the ETF is traded like a stock and based on supply and demand (there is a buyer for every seller), therefore there are no issues of redemptions.
In most cases, ETF fees and portfolio turnover are lower than traditional mutual funds. This means you get to keep more of your money since you will pay less in taxes and management fees.

In order to purchase an ETF, you simply open up a brokerage account and buy and sell it much like you would a stock. Dollar cost averaging is possible. Unfortunately, you will incur expenses in the form of commissions. If you are dollar cost averaging into 5 or 10 different ETFs, this may be cost prohibitive and you might want to consider a low cost mutual fund.

To search for ETFS, do a search on Ishares, or go directly to www.morningstar.com.

For investors who want exposure to a market sector, ETFs can be an ideal investment as they offer a great deal of flexibility, minute by minute trading capabilities and low cost to entry. Options are also available on many of popular ETFs.

Larry Lane is the editor for InvestorZoo, a social networking site dedicated to personal finance. Email questions and comments to Larry.Lane@InvestorZoo.com

The above article is information of a general nature. Please consult with a licensed financial planner before making any financial decision.