Rudiments of ETF - Exchange Traded Funds

Exchange-traded funds (ETFs) are a type of financial instrument whose unique advantages over mutual funds have caught the eye of many an investor. If you find the tasks of analyzing and picking stocks a little daunting, ETFs may be right for you.

In this post lets define ETFs, highlight their advantages .......

What Is an ETF?

Think of an exchange-traded fund as a mutual fund that trades like a stock. Just like an index fund, an ETF represents a basket of stocks that reflect an index such as the S&P 500, BSE Sensex, Nifty.

An ETF, however, isn't a mutual fund; it trades just like any other company scrip on a stock exchange. Unlike a mutual fund that has its net-asset value (NAV) calculated at the end of each trading day, an ETF's price changes throughout the day, fluctuating with supply and demand. It is important to remember that while ETFs attempt to replicate the return on indexes, there is no guarantee that they will do so exactly. It is not uncommon to see a 1% or more difference between the actual index's year-end return and that of an ETF.

By owning an ETF:

• you get the diversification of an index fund plus the flexibility of a stock.
• Further, as ETFs trade like stocks, you can short sell them, buy them on margin and purchase as little as one share.
• Another advantage is that the expense ratios of most ETFs are lower than that of the average mutual fund. When buying and selling ETFs, you pay your broker the same commission that you'd pay on any regular trade.

Varieties of ETFs The first exchange-traded fund was the S&P 500 index fund (nicknamed spiders because of their SPDR ticker symbol), which began trading on the American Stock Exchange (AMEX) in 1993. Today - tracking a wide variety of sector-specific, country-specific and broad-market indexes - there are hundreds of ETFs trading on the open market. You can pretty much find an ETF for just about any kind of sector of the market.

All ETFs are passively managed, meaning investors save big on management fees.

SPDRs : Usually referred to as spiders, these investment instruments bundle the benchmark S&P 500 and give you ownership in the index. Imagine the trouble and expenses involved in trying to buy all 500 stocks in the S&P 500! SPDRs allow individual investors to own the index's stocks in a cost-effective manner. Another nice feature of SPDRs is that they divide various sectors of the S&P 500 stocks and sell them as separate ETFs, there are literally dozens of these types of ETFs. The "technology select sector index", for example, contains over 85 stocks covering products developed by companies such as defense manufacturers, telecommunications equipment, microcomputer components, and integrated computer circuits.


Conclusion A great reason to consider ETFs is that they simplify index and sector investing in a way that is easy to understand. If you feel a turnaround is around the corner, go long. If, however, you think ominous clouds will be over the market for some time, you have the option of going short. The combination of the instant diversification, low cost and the flexibility that ETFs offer, makes these instruments one of the most useful innovations and attractive pieces of financial engineering to date.

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Disclaimer: The author of this page is not a registered financial advisor, and you should not construe anything written here to be investment advise. You should consult a qualified broker or other financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. No representation is being made that any investment made on the basis of data or information on this blog will result in profits. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments.