What Is an Exchange Traded Fund? - dummies

By Matt Krantz

If you are new to online investing, you may not be familiar with Exchange Traded Funds (ETFs). ETFs are baskets of stocks, much like mutual funds, that trade like stocks. You can buy and sell them using your online broker just like you would with other stocks.

[Credit: ©iStockphoto.com/vetkit]
Credit: ©iStockphoto.com/vetkit

All ETFs have trading symbols and qualify for the low commission rates from online brokers. Several online brokers, including Fidelity and Charles Schwab, even let you trade some ETFs for no commission. You can even get price quotes by using your favorite stock-tracking Web sites.

You can buy and sell ETFs by using the online broker you’ve already signed up with. Just enter the ETF’s trading symbol, and you can buy and sell just like you would shares of a company’s stock.

Online investors like ETFs because they’re easy to buy without the hassle of signing up for accounts with mutual fund companies or checking to see whether they’re transaction-free. ETFs have the same advantages of mutual funds. That includes diversification and access to specific corners of the stock market, including certain sizes of stocks or industries. ETFs, though, offer several advantages over mutual funds, including the following:

  • Intraday trading: Mutual funds price once a day, meaning that you don’t know how your portfolio has done until the markets close and the fund companies get around to publishing the net asset value (NAV) for the day. The prices of ETFs constantly update during the day just like stocks.

  • Access to tougher areas of the market: Investors interested in buying commodities, bonds, and currencies can buy them easily, just like buying a stock, thanks to ETFs. And because ETFs are priced during the day, speculators can get in and out of risky positions anytime they want. ETFs are a great way to add foreign exposure to your portfolio.

  • Low fees: If you thought the fees on index mutual funds were low, ETFs in many cases are even lower. It’s not unusual for ETFs to charge lower maintenance fees than mutual funds that mirror the same stock index by owning all the stocks in the index. The average expense ratio of ETFs is roughly 0.5 percent, well below the 1.0 percent charged by mutual funds.

  • Tax advantages: Due to their structure, ETFs rarely stick investors with capital-gain distributions. That helps investors plan tax strategies. Keep in mind, though, many ETFs still pay dividends, which are usually taxable.

  • Offer advanced trading options: Most ETFs offer options. That’s attractive to investors who want to do more than just buy or sell the investments. ETFs can also be shorted.