Find the answers to your ETF questions here.
What is an exchange-traded fund (ETF)?
An exchange-traded fund, or ETF, is an index fund (a portfolio or ‘basket’ of securities) that you can buy or sell like a stock (through a brokerage firm). In the U.S., you can find ETFs listed (with ticker symbols) on the American Stock Exchange, the New York Stock Exchange, or the NASDAQ.
Learn more:
· Mutual Funds: Exchange-Traded Funds
· ETF Industry Headed for Another Record Year
What is an index fund?
ETFs are essentially index funds. Index funds represent what is often referred to as indexing or ‘passive investing.’ Index investors buy and hold a large predetermined group of securities (an index or market segment) and hold them. In other words, an index fund is ‘passively managed’ (minimal trading of stocks within the ETF) which results in a low portfolio turnover and a low management fee (or expense ratio).
Learn more:
· Index
What indexes do ETFs track?
ETFs track the performance of a variety of stock, bond, and commodity indexes.
The primary asset classes in which ETFs are available:
· Large Cap Stocks
· Mid Cap Stocks
· Small Cap Stocks
· Growth Stocks
· Value Stocks
· Sector Stocks
· International Stocks
· Emerging Market Stocks
· Long-term Bonds
· Mid-term Bonds
· Short-term Bonds
· Real Estate Investment Trusts
Learn more:
· 1/2/ETF Industry Headed for Another Record Year
How do I buy or sell ETFs?
In the U.S., ETFs are listed with ticker symbols on the main stock exchanges and a brokerage commission will typically apply per trade. You can buy or sell shares of ETFs just as you would any stock – throughout the trading day, via a brokerage firm. You can also use various stock trading methods, such as limit orders, stop-loss (or stop-limit) orders, short selling, and buying on margin.
Learn more:
· ETF
· What Do I Need to Know About Shorting Stocks?
What is the difference between an ETF’s market price and its net asset value (NAV)?
From the TheStreet.com University Glossary:
Each ETF has a net asset value (NAV), which is determined by the total market capitalization of the stocks in the portfolio, plus dividends but minus expenses, divided by the number of shares issued by the fund.
ETF prices change throughout the trading day, in response to supply and demand, rather than just at the end of the trading day as open-end mutual fund prices do.
The market price and the NAV are rarely the same, but the differences are typically small. That's due to a unique process that allows institutional investors to buy or redeem large blocks of shares at the NAV with in-kind baskets of the fund's stocks.
What are the benefits of investing in ETFs?
From TheStreet.com’s “Learn the ABC’s of ETFs:” ETFs offer investors exposure to domestic indices such as the S&P and Dow Jones Industrial Average as well as to various international indices. The specific investment style of an index ETF can represent a specific sector or industry such as semiconductors, a broad market index such as the S&P 500 or a specific basket of stocks. In addition, various funds may focus on differing investment styles such as value or growth.
Aside from the liquidity benefits, a wide range of factors are behind the surge in ETF popularity:
· Diversification: Like index mutual funds, ETFs provide diversified exposure to an index, industry, sector or group of stocks. However, unlike mutual funds, ETFs do so in a single investment vehicle that can often be hedged with options.
· Tax advantages: Unlike mutual funds, ETFs have no hidden capital gains; taxes are owed only on gains that are actually realized.
· Lower costs: According to Morningstar, the average expense fee for ETFs is 0.46%, and it can be as low as 0.09% for highly liquid ETFs. The average index mutual fund expense ratio is nearly double that, at 0.88%.
· Transparency: The holdings of index ETFs are available on a daily basis. Active mutual funds generally reveal their entire holdings just twice a year.
Learn more:
· Mutual Funds: Exchange-Traded Funds
What are the risks associated with ETFs?
· ETF shares may be valued less than their original cost at the time of sale.
· ETFs are not FDIC-insured.
· Past performance is not a guarantee of future results.
· Infrequent and small trades reduce the benefits of flat transaction fees.
Learn more:
· Watch Out for ETF Misinformation
What are the typical fees involved with ETFs?
The two primary fees associated with buying, owning, and selling an ETF are its management fee (or expense ratio) and your broker’s commission. Since ETFs are ‘passively managed,’ the expense ratios are typically lower than ‘actively managed’ mutual funds. ETF expense ratios are usually less than 1 percent. However, this will vary among ETF products. You can obtain the exact ratios from each ETF’s prospectus.
· TheStreet.com Ratings: Beware High-Fee ETFs
What is the basis for the liquidity of an ETF?
The liquidity of an ETF is not based on the ETF’s average trading volume or the number of ETF shares traded per day. The liquidity of an ETF is mainly based on the liquidity of the underlying stocks or bonds in its index.
Do ETFs pay dividends?
Yes. The dividends from the underlying
securities in an ETF’s portfolio are distributed to shareholders, either
quarterly or monthly, depending on the fund.
How are ETF gains taxed?
ETFs have lower tax liabilities. Why? Low portfolio turnover.
As an ETF investor, you can pay most of your capital gains upon the final sale of your ETF shares. Exactly how much you might benefit after-taxes depends on your marginal tax rate, the return of the investment, and how long you’ve held the shares.
At the end of the day, ETFs are similar to tax managed index mutual funds.
Learn more:
· Booyah Breakdown: Taxes for Traders, Part I
· Booyah Breakdown: Taxes for Traders, Part II
What are three main ETF structures?
ETFs adhere to one of three legal structures:
|
Type/Format |
Characteristics |
Examples |
Open-End Index Fund |
· Reinvests dividends into the fund on the date of receipt · Pays dividends via a quarterly cash distribution · Permitted to use derivatives and loan securities · Registered under the SEC Investment Company Act of 1940 |
· iShares · Select Sector SPDRs |
Unit Investment Trust |
· Does not reinvest dividends into the fund · Pays dividends via a quarterly cash distribution · Can deviate from the exact composition of a benchmark index · Registered under the SEC Investment Company Act of 1940 |
· The Diamonds · Cubes · SPDRS |
Grantor Trust |
· Distributes dividends directly to shareholders · Allows shareholders to retain their voting rights on the underlying securities within the fund · Not registered under the SEC Investment Company Act of 1940 |
· Merrill Lynch’s HOLDRs |
How do I manage a portfolio with ETFs?
Whether you consider yourself an aggressive or conservative investor, you can find ETFs that best fit your investing style and goals. And, ‘knowing what you own’ is essential to maintaining a healthy portfolio.
· Portfolio Readjustment: Constructing a Portfolio the ETF Way
· Portfolio Readjustment: Follow Three Steps to Financial Health