Business: Exchange Traded Funds 101

So you have a few dollars to invest. Maybe you put money in your IRA or your 401k gives you a wide range of investment choices. Maybe you have money in the bank which is in addition to any emergency that you need and want to make it work harder for you. If this is the case, it is time to learn about ETFs.

I am often surprised at the number of people who come to me are not familiar with Exchange Traded Funds. They have become one of the most important products available to the general public and all those who want to invest must know what they are and understand.

First a little history: The ETF had their beginning in 1989 with a "stock-like" who tried to match the performance of the S & P 500. This product has encountered problems of patents and sales arrested in the United States. Another product was offered to the Toronto Stock Exchange in 1990 and became so popular that it led the American Stock Exchange to develop something that would satisfy SEC regulations in the United States.

And SPDR or "spider" (which means Standard & Poor's Depositary Receipts, symbol SPY) were born in January 1993, becoming the largest ETF in the world.

Then were supported MidCap SPDRs and the race began to create a new industry. Barclays entered the fight in 1996 WEBS --- Global Equity Benchmark equity shares which became iSharesMSCI Index Fund. WEBS Index 17 countries that followed was an innovative way for the world to access foreign ownership inexpensively and easily.

In 1998, State Street has introduced "spiders" sector that followed the nine sectors of the S & P 500and in 1998: "Dow Diamonds" were introduced, the monitoring of Industries Dow Jones. In 1999, "cubes" QQQ QQQQ or (today) have been introduced to reproduce the movement of the NASDAQ-100 Index. since then, ETFs have proliferated, tailored to a variety of more specific regions, sectors, commodities, bonds, futures and other asset classes amounting to more than $ 1 trillion invested.

Before we dive deeper into the ETF, we should learn a little more about the indices. An index is a list of all the financial instruments used to track a particular market. For example, the Dow Jones Industrial Average is an index that tracks the performance of 30 large publicly traded companies.

Any mutual fund to invest in these stocks would be 30 called an index fund. The sole purpose would be to give the investor the opportunity to own something that mimics the movement and performance of these 30 titles. Today, the index most widely held is that which follows the S & P 500. The S & P 500 represents 500 companies that many consider to be the trend indicators of the U.S. economy.

Just like mutual funds that invest in all kinds of indices, there are now ETFs that do the same thing and yet ETFs have major advantages of design. We will compare the two:

a) the internal costs of mutual funds are often higher than the ETF, which allows the ETF to obtain a yield close to the index. Lower internal costs means higher yields.

b) The buyer or seller mutual fund will receive the award at the close of business each day. An ETF can be traded throughout the day creating a great advantage if the market is a powerful movement. In times of significant market movements, being able to negotiate in real time is greater than having to accept the prize at the end of the trading session.

c) unlike a mutual fund, stock characteristics as an ETF can use a limit order or a stop-loss order, be short sold and traded on margin.

d) A mutual fund is required by law to distribute capital gains at year end, and ETF does not distribute much in the way of capital gains taxes help maintain controlled.

ETFs are not perfect, however. They have some disadvantages compared to mutual funds.

a) ETF shares similar characteristics lend themselves to a higher degree of negotiation and short-term speculation led, in many cases, under-performance if used unwisely.

b) As the buying and selling of stocks, ETFs generate brokerage commissions that can add up over time and reduce yields.

c) Many new ETFs track baskets obscure and complicated securities that are not tested on the market. These baskets of goods are the currencies of bonds adding further risk.

d) There are ETFs that magnify the movement of the underlying index by 2 or 3 times what makes a dangerous instrument, even in experienced hands.

It has many more differences both good and bad between the ETF and mutual fund counterparts, so that their use must be understood before an investment. Ultimately speaking as an experienced advisor, I can recommend their use in most cases.

Business

Thursday, December 27, 2012

Exchange Traded Funds 101

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