Posted by Karen Munoz, EA

Understanding the Concept of Exchange Traded Funds

Understanding the Concept of Exchange Traded Funds

Exchange-traded funds are investment types that combine the best advantage of two assets. As a result, users enjoy the benefit of diversification of mutual funds alongside the ease of stock trading. 

An Exchange-traded fund (ETF) can be traded like a stock, implying that people can buy and sell it any time of the day. Compared to other fund types, they have lower fees and varying risk levels, depending on the style. 

One, however, needs to examine an ETF based on the pros (not forgetting commission fees and management costs) as it is not a one-size-fits-all solution.

 

Exchange-Traded Funds: How They Work

The fund provider, who is the owner of the underlying assets, sets up funds to monitor performance and offers shares for sale in such funds. Thus, shareholders take possession of some part of the ETF through the main asset present in the fund that does not belong to them. In addition, ETF investors keeping track of the stock index might get reinvestment for the stock, which is part of the index. 

Even though the main idea behind EDT design is to keep tabs on the value of an asset, their trade prices are determined by market forces that are not the same as the asset. In addition, due to things like expenses, longer-term returns do vary for an ETF, different from the underlying assets.

 

Exploring the Pros and Cons of ETF

ETF.com, an offset of Chicago Board Options Exchange, revealed a 55% increase in the funds paid into the ETF in 2020, compared to 2019. The reason it attracted investors can be traced to affordability, ease of accessibility, and simplicity. 


Here are the pros of the ETF Investment 

Transparency: 

As long as there is internet access, you can quickly get the price activity for a specific ETF in the exchange. Also, there is the day-to-day announcement of the fund's holding to the public. With mutual funds, on the other hand, this is a monthly or quarterly exercise.

 

Tax Benefits:

 It is only when the investor sells the investment that they are taxed. Mutual funds, on the other hand, have this burden over the life of their investment.


Flexible Trading: 

The prices of ETFs, like Stocks, are real-time, and the trade goes on through the day. On the other hand, mutual funds do not enjoy this advantage as the pricing is a matter of the trading prices when the day ends.

 

Cons of ETF Investment 

Liquidity Issues: like any security, you are at the mercy of the recent market prices when you want to sell, and ETFs that are not frequently traded could be hard to unload. 

Risk of ETF closing: this happens because there is no enough asset from the funds to take care of administrative fees. Also, investors at times need to sell sooner than they project and might not be for gain. 


Getting the Right ETF for Your Portfolio 

You should understand that even though ETFs generally have lower costs, such is not the same with every fund. It is a factor of the issuer and also depends on the demand and complexity. 

Many ETFs are passive investments as they track an index that does not augur well with some investors. They love and prefer being part of their investment like what mutual funds offer, operated by a professional that tries to outsmart the market. 

Many ETFs are actively managed, and they resemble mutual funds even though the fees are higher, which makes it essential to explore your investment style before making a choice. 


Investing in ETFs

There are many ways one can invest in ETFs, but the main investment style is a factor of your preference. For veteran investors, you need just a couple of clicks to invest in an ETF. Assets like these are standard offerings with online brokers, even though there are some discrepancies in the fees and number of offerings. 

On the other hand, some Robo-advisors make their portfolios with low-cost ETFs and make them available to hands-off investors. 

In conclusion, ETFs come with subtle differences one can easily understand. With these basics here, you can decide if an ETF is the best choice for your portfolio or not. 


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Karen Munoz, EA
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