The best way to understand about Exchange Traded Funds is to start with a traditional mutual fund. Imagine that around half a dozen investors are trying to figure out the best way to invest in a stock market. They can each go out and buy stocks on their own but do not have the time or the resources.
Hence, they come together and pool their money to hire a fund manager to invest for them. In a similar way, Exchange Traded Funds are a pool of investment which provides exposure to an area of the market. You can invest in stocks, commodities, currencies, and other options.
The main difference comes in the Exchange Traded Funds is that you can buy shares from any brokerage account. More importantly, you can do it at your convenient time. Exchange Traded Funds trades take place anytime in the market is open. You can buy shares in the morning, sell them in the evening.
There are many other benefits of the Exchange Traded Funds. Hence, by definition, Exchange Traded Funds is an investment fund traded on the stock exchange like stocks. It holds assets like stocks, commodities, bonds to its net asset value over the course of the trading day.
Exchange Traded Funds are an attractive option because of the low costs, tax efficiency, and stock-like features. But, only authorized people, large brokers, dealers who have entered into an agreement with ETF distributor can actually trade them.
Features of Exchange Traded Funds
Below are some of the features of the Exchange Traded Funds.
- Exchange Traded Funds are a good investment option for the small investors. The arbitrageurs ensure that the ETF prices are kept close to the NAV of the underlying securities.
- An ETF pays out dividend received from the underlying stocks on a quarterly basis. Thus, they can hold cash for various time frames throughout the quarter.
- Since the Exchange Traded Funds are managed stocks, they offer greater tax benefits than the usual mutual funds.
- The Exchange Traded Funds are designed to replicate the performance of the commodity or the underlying index. The investors always know exactly what they are buying. The fees are also laid out.
- The ETF have a low annual fee as compared to traditional mutual fund. The people who generally invest in the ETFs can increase the cost of investing in the ETFs.
Advantage of Exchange Traded Funds
ETFs continue to gain popularity and gather assets on a rapid pace. Below are some of the advantage of the Exchange Traded Funds.
- Unlike traditional stocks, the Exchange Traded Funds can be traded throughout the day. They provide an opportunity for speculative investors to bet on the direction of shorter term market movements.
- Exchange Traded Funds shine when it comes to saving money. They offer all the benefits of the index stock and cost a lot less.
- Exchange Traded Funds come in handy when investors want to create a diversified portfolio.
- Exchange Traded Funds are a favourite amongst the tax aware investors. The unique structure of Exchange Traded Funds allows the investors who are trading in large volumes to receive in-kind redemptions.
Disadvantages of Exchange Traded Funds
Although Exchange Traded Funds advantages look promising the cons cannot be ignored.
- The long-term investors might not enjoy the intraday pricing changes. Hence, they may trade more due to the lagged pricing.
- The niche ETFs have a low volume index.
- The dividend paying yields can be high, but not as high as the owning a high yield stock or a group of stocks.
- Exchange Traded Funds have been around since the 1980s. They gained popularity as investors started looking for options besides mutual funds. But, the burden of choosing the right investment option lies upon the person making the investment.