Exchange-Traded Funds: The New Kid on the Block - dummies

Exchange-Traded Funds: The New Kid on the Block

By Russell Wild

In a world of very pricey investment products and very well paid investment-product salespeople of Wall Street, exchange-traded funds (ETFs) are the ultimate financial killjoys.

Since their arrival on the investment scene in the early 1990s, more than 1,300 ETFs have been created, and ETF assets have grown faster than those of any other investment product. That’s a good thing. ETFs enable the average investor to avoid shelling out fat commissions or paying layers of ongoing, unnecessary fees. And they’ve saved investors oodles and oodles in taxes.

The start of exchange-traded funds

The first ETF was introduced in Canada, a creation of the Toronto Stock Exchange.

The story of the development of ETFs isn’t quite as exciting as, say, the story behind penicillin or the atomic bomb. As one Toronto Stock Exchange insider once explained, “We saw it as a way of making money by generating more trading.” Thus was born the original ETF known as TIP, which stood for Toronto Index Participation Unit.

The TIP tracked an index of large Canadian companies (Bell Canada, Royal Bank of Canada, Nortel, and 32 others) known as the Toronto 35. That index was then the closest thing that Canada had to the Dow Jones Industrial Average index that exists in the United States.

Enter the traders

TIP was an instant success with large institutional stock traders, who saw that they could now trade an entire index in a flash. The Toronto Stock Exchange got what it wanted — more trading. And the world of ETFs got its start.

The move south of the border

The first ETF didn’t come to the United States for three or so years after its Canadian birth. On January 22, 1993, the Mother of All U.S. ETFs was born on the American Stock Exchange (which, in January 2009 — a big year for mergers and acquisitions — became part of NYSE Euronext).

The first U.S.-based ETF was called the S&P Depositary Receipts Trust Series 1, commonly known as the SPDR (or Spider) S&P 500, and it traded (and still does) under the ticker symbol SPY.

The SPDR S&P 500, which tracks the S&P 500 index, an index of the 500 largest U.S. companies, was an instant darling of institutional traders. It has since branched out to become a major holding in the portfolios of many individual and institutional investors — and a favorite of favorites among day-traders.