What is an ETF?

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An ETF is an Exchange Traded Fund.  An ETF is a special type of mutual fund that can be bought and sold on a major stock exchange using its ticker symbol.  Because it is traded on a major exchange, it is considered an exchange traded fund.

What makes them special?

ETFs are generally easier and cheaper to buy and sell than a traditional mutual fund.  Most brokerage firms charge the same fee as a stock trade to buy or sell ETF shares.  That fee is generally much lower than a mutual fund trade.

ETFs generally also have lower ownership fees.  While most mutual funds charge up to about 2% for management fees, administrative fees, and marketing fees, most ETFs charge less than 1%.  That does not take into account load fees (transaction fees) that some mutual funds charge.  I own two ETFs and both charge less than .25% in fees.

ETFs are also generally traded at a much higher frequency than traditional mutual funds.  Higher liquidity is an important consideration when making an investment.

What types of ETFs are there?

The best known ETF is an index fund.  Index funds are ETFs that are built to mirror a specific index.  The most popular index funds track the S&P 500, Dow Jones Industrial Average, NASDAQ composite average, and Russell 2000.  One of the most popular ETFs in the world is the SPTR ETF from State Street.  They also run the popular SPY ETF.

Some ETFs are designed to track a specific commodity.  If you want to have exposure to any traded commodity, there is most likely an ETF that can get you into that commodity without the risk of trading the actual commodity.  The popular gold ETF (ticker GLD) from State Street tracks the price of gold.  You can also buy ETFs that track oil, silver, platinum, corn, livestock, coffee, carbon credits, natural gas, cocoa, heating oil, sugar, soybeans, nickel, tin, and a long list of others.  You can also buy commodity ETFs that cover a range of commodities, such as precious metals or grain ETFs.

Fixed income ETFs are popular among investors who wish to have exposure to bond investments without buying a specific government or corporate bond.  Bond ETFs are generally less volatile than commodities and generally pay a dividend.  Like bonds, bond ETFs are impacted by interest rate fluctuations more than stocks.

If you want to get into currency trading with less risk than buying millions of Euros or Yen, you might consider a currency ETF.  Currency ETFs allow you to buy or short sell foreign currencies without having to go through conversions or currency brokers.  Instead, you can buy and sell with a ticker symbol.

Leveraged ETFs allow you to increase the impact to your portfolio from a single ETF.  These ETFs give you much more bang for your buck.  These speculative ETFs give you a much higher risk.  For example some leveraged ETFs give you triple exposure to fluctuations in the S&P 500.

Should you buy an ETF?

Like any investment option, ETF purchases should be made if they match your goals.  I wanted to have emerging market exposure without buying a specific stock, so I got the Schwab Emerging Market ETF (SCHE).  I also wanted a wide range of small cap stocks, so I bought shares of the Schwab Small Cap ETFS (SCHA).  I like the Schwab ETFs because I can buy them without any trade fees through my brokerage account and they have very low fees.

If you have cash sitting in your account, you might buy a treasury fixed income ETF to earn a little extra interest.  If you want exposure to a wide range of stocks without the high fees of a mutual fund, you should definitely look at ETFs.  If you want to get into derivatives with less risk than buying options on commodities or currencies, ETFs are a great place to start.

Your portfolio and experience

Do you have ETFs?  Have you tried ETF investing the past?  What were your experiences?  Please share in the comments.

2 thoughts on “What is an ETF?”

  1. Eric - Narrow Bridge

    Now you just need to throw in a few bucks and start investing! Thanks for the comment Brett.

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