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.
Another important consideration is that most of the more liquid ETFs are optionable. This means that option-savvy investors can harness the power of stock options to change the risk-reward profile of their positions, and risk-conscious investors can use stratagems such as the covered call and protective put to protect their investment.
When investing in ETFs, its important to consider how exactly that ETF works. This can usually be found with a quick google search. While most ETFs attain their returns simply by holding the underlying securities, other ETFs use more exotic means to match their benchmark/investment objective, sometimes with varying success. Particularly important is the differentiation between an ETF and an ETN. ETNs are debt based investments, similar to bonds in some ways, and so their value is also partially dependent on the issuer. For this reason, investments in ETNs should be approached with caution, especially in the current, credit-tight market.
ETFs are a powerful tool for both the intelligent investor, and the active trader. Their ability to hone in and diversify within a given industry, or region of the world is invaluable when riding the larger megatrends that happen periodically in investment. Similarly, the ability to trade them just like a stock, using techniques such as shorting, options, and the various order types make them an invaluable asset for the active trader. For those believing the efficient market hypothesis, they even allow passive index investing at a cost far below that of a mutual fund.
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.
Another important consideration is that most of the more liquid ETFs are optionable. This means that option-savvy investors can harness the power of stock options to change the risk-reward profile of their positions, and risk-conscious investors can use stratagems such as the covered call and protective put to protect their investment.
When investing in ETFs, its important to consider how exactly that ETF works. This can usually be found with a quick google search. While most ETFs attain their returns simply by holding the underlying securities, other ETFs use more exotic means to match their benchmark/investment objective, sometimes with varying success. Particularly important is the differentiation between an ETF and an ETN. ETNs are debt based investments, similar to bonds in some ways, and so their value is also partially dependent on the issuer. For this reason, investments in ETNs should be approached with caution, especially in the current, credit-tight market.
ETFs are a powerful tool for both the intelligent investor, and the active trader. Their ability to hone in and diversify within a given industry, or region of the world is invaluable when riding the larger megatrends that happen periodically in investment. Similarly, the ability to trade them just like a stock, using techniques such as shorting, options, and the various order types make them an invaluable asset for the active trader. For those believing the efficient market hypothesis, they even allow passive index investing at a cost far below that of a mutual fund.
About the Author:
You must learn the ways of the market before you can truly succeed there, 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! Learn the stock option strategies you NEED to know in order to acheive the monstrous returns you'd LOVE to have!
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