The ETF Advantage

Category : Blog on February 24, 2019

An Exchangetf smalle Traded Fund (ETF) is a valuable component for any investor’s portfolio. ETFs are traditionally (and still predominantly) passive investment vehicles. This means rather than attempting to beat the performance of a stock or bond index, an ETF will instead attempt to closely replicate the index performance. The original and probably most widely known ETF was created by State Street Global Advisors to track the S&P 500 index (symbol SPY). This was the first in what became a family of ETFs known as “Spiders” (Standard & Poor’s Depositary Receipts – SPDR).

ETFs are traded like individual stocks on an exchange such as the New York Stock Exchange and can be bought and sold through brokers in the same way as any other listed stock. This mechanism provides great liquidity as transactions can take place any time during normal stock market trading hours. Our three favorite characteristics of ETFs are their cost, tax efficiency, and asset class and style representation.

Low Cost  

The predominantly passive nature of ETFs means that operating costs can be kept very low. There are none of the active management fees found in many traditional mutual funds. Turnover of securities within an ETF is minimal as their investment object is to track an index, the constituents of which are not usually altered very often. In addition to being low cost in principle, the ETF industry has exploded over the past 10 years with the number of products available increasing more than 1000%. The resulting competition has driven expense ratios down in what could only be described as a race to the bottom. Many ETF expense ratios are now below 0.15%, and some are below 0.10%.

Tax Efficient  

ETFs handle redemptions differently to regular mutual funds. Most commonly the shares are simply sold directly to another investor on the open market. If the number of shares is large enough (a size known as a creation unit) an investor may also redeem directly from the ETF. In this case the ETF returns the actual shares in the underlying index to the redeeming entity. This in-kind process is by choice (ETFs and mutual funds are governed by the same laws) and is simply how the redemption process works. Both the open market transfer and the in-kind process enable redemptions to take place without the fund manager selling anything and passing on unwanted capital gains to the remaining shareholders.

Access to Different Asset Classes  

There are ETFs which cover every major index, asset class, and niche an investor can imagine. ETFs offer access to many investment strategies, ranging from large-caps like the S&P 500 and Dow Jones to more concentrated investment themes, such as, for example, sector ETFs tracking health care or information technology stocks. Exposures also go beyond traditional stocks and bonds to more exotic and alternative asset classes like commodities such as gold and oil. Investors can even add real estate investments to their portfolio by purchasing a niche ETF in the REIT market. An entire portfolio of diversified investments can be created using ETFs.

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Investing Quotes

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    • “Be fearful when others are greedy. Be greedy when others are fearful.”

      —Warren Buffett

    • “The individual investor should act consistently as an investor and not as a speculator.”

      —Benjamin Graham

    • “Know what you own, and know why you own it.”

      —Peter Lynch

    • “Sometimes your best investments are the ones you don’t make.”

      —Donald Trump

    • “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”

      —George Soros

    • “My favorite holding period is forever.”

      —Warren Buffett

    • “The essence of investment management is the management of risks, not the management of returns.”

      —Benjamin Graham

    • “You make most of your money in a bear market, you just don’t realize it at the time.”

      —Shelby Davis

    • “We have two classes of forecasters: Those who don’t know and those who don’t know they don’t know.”

      —John Kenneth Galbraith

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