ETFs: Investing for the 21st century
It has been consistently demonstrated that your investment returns aren't so much a function of what stocks your invested in, but what sectors/asset classes your invested in. In the dot com boom, it didn't matter what dot com stock you invested in, if you were invested in dot com companies, you probably did alright. During the dot com bust, it wasn't just a couple select companies that went down, it was just about all of them. Because of this tendency for similar stocks to move together, it is much more productive to be able to simply buy " or short - a type of stock, then try and nail the exact right company. But how can you gain exposure to a sector without taking unnecessary risk based on the company?
Exchange Traded Funds are the answer. Exchange traded funds (ETFs) allow you to invest in a group of companies all at once, similar to a mutual fund. The difference is that ETFs are traded directly on a stock exchange just like a stock, they can be bought and sold any time during the day without penalty, and they are both shortable, and optionable allowing you to take advantage of both up, and down moves in the market.
ETFs can focus on certain regions; China for instance, is represented by the FXI. ETFs can focus on certain sectors; Those playing financial stocks may find XLF interesting. It can even focus on certain capitalizations; Those wanting diversification across small cap companies can make a single investment in IWM.
Yet if ETFs are so similar to mutual funds, why not just use a mutual fund. There really are a couple reasons to do so. First off, mutual funds have a history of underperforming the stock market as a whole after fees are included. This makes simple index investing, through an ETF representing a large basket of stocks, such as the SPY, an extremely effective way of matching the markets returns with nearly no cost. There are also slight tax advantages with ETFs compared to mutual funds. Mutual funds have to pay capital gains tax whenever they sell one of their holdings, and whenever they have a large wave of redemptions, they have to sell their positions to come up with the money. This leads to excess fees, some of which get passed on to the remaining investors.
Another advantage held by ETFs is their great convenience over their mutual counterparts. Many mutual funds have redemptions fees if you exit within 30 days, whereas ETFs aren't plagued by this problem. Also, unlike mutual funds, you can go short an ETF, benefiting from a fall in a sector instead of a rise. ETFs can also be bought and sold any time during the trading day, using limit orders, stop losses, and all the other tools you can use for buying stock.
A great boon to ETF investors, never before experienced by mutual fund holders, is the ability to use stock options to control risk. Stock options can be used to reduce the risk by using covered calls, or buying protective puts. Alternatively, call options can be used to control maximum loss, and potentially increase profits.
One thing to note is that not all ETFs are created equal. While some simply hold a basket of stocks and use those to keep the ETFs value near the benchmark, many use other, more exotic strategies, with various degrees of success. QLD for instance, aims to gain roughly twice the daily returns of the Nasdaq composite index, and is usually fairly consistent when doing this. Another similar instrument is the ETN, which is actually a debt based instrument. While ETNs also aims to gain returns based on a given benchmark, there price is also sensitive to changes in the debt rating of the issuer, and this should be considered when investing in them.
ETFs are a diverse tool that allows one to remove risk from ones portfolio by investing in sectors instead of individual companies. They allow investors to benefit from downturns in markets as well as the uptrends. And they allow the investor to take advantage of options on sectors, which options-savvy investors can use to supercharge returns. Given their great variety of uses, ETFs should be a valued part of any investors portfolio, to be ignored at the investors peril. - 23204
Exchange Traded Funds are the answer. Exchange traded funds (ETFs) allow you to invest in a group of companies all at once, similar to a mutual fund. The difference is that ETFs are traded directly on a stock exchange just like a stock, they can be bought and sold any time during the day without penalty, and they are both shortable, and optionable allowing you to take advantage of both up, and down moves in the market.
ETFs can focus on certain regions; China for instance, is represented by the FXI. ETFs can focus on certain sectors; Those playing financial stocks may find XLF interesting. It can even focus on certain capitalizations; Those wanting diversification across small cap companies can make a single investment in IWM.
Yet if ETFs are so similar to mutual funds, why not just use a mutual fund. There really are a couple reasons to do so. First off, mutual funds have a history of underperforming the stock market as a whole after fees are included. This makes simple index investing, through an ETF representing a large basket of stocks, such as the SPY, an extremely effective way of matching the markets returns with nearly no cost. There are also slight tax advantages with ETFs compared to mutual funds. Mutual funds have to pay capital gains tax whenever they sell one of their holdings, and whenever they have a large wave of redemptions, they have to sell their positions to come up with the money. This leads to excess fees, some of which get passed on to the remaining investors.
Another advantage held by ETFs is their great convenience over their mutual counterparts. Many mutual funds have redemptions fees if you exit within 30 days, whereas ETFs aren't plagued by this problem. Also, unlike mutual funds, you can go short an ETF, benefiting from a fall in a sector instead of a rise. ETFs can also be bought and sold any time during the trading day, using limit orders, stop losses, and all the other tools you can use for buying stock.
A great boon to ETF investors, never before experienced by mutual fund holders, is the ability to use stock options to control risk. Stock options can be used to reduce the risk by using covered calls, or buying protective puts. Alternatively, call options can be used to control maximum loss, and potentially increase profits.
One thing to note is that not all ETFs are created equal. While some simply hold a basket of stocks and use those to keep the ETFs value near the benchmark, many use other, more exotic strategies, with various degrees of success. QLD for instance, aims to gain roughly twice the daily returns of the Nasdaq composite index, and is usually fairly consistent when doing this. Another similar instrument is the ETN, which is actually a debt based instrument. While ETNs also aims to gain returns based on a given benchmark, there price is also sensitive to changes in the debt rating of the issuer, and this should be considered when investing in them.
ETFs are a diverse tool that allows one to remove risk from ones portfolio by investing in sectors instead of individual companies. They allow investors to benefit from downturns in markets as well as the uptrends. And they allow the investor to take advantage of options on sectors, which options-savvy investors can use to supercharge returns. Given their great variety of uses, ETFs should be a valued part of any investors portfolio, to be ignored at the investors peril. - 23204
About the Author:
The first step to making money in the markets is learning them, so visit my website and become a market virtuoso! Come and master "insider secrets" such as ETF Investing, stock option strategies, sector rotation, and shorting stock! Unleash the true power of ETFs in your portfolio, and allow your portfolio to be the best it can be
posted by X - Men @ 3:57 AM
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