Are Exchange Traded Funds (ETFs) The Best of All Worlds?

An Exchange Traded Fund (ETF) is an investment fund that trades on one or more stock exchanges much like a stock. It can therefore be bought or sold on the relevant stock exchange at any time of the day.

An ETF also mimics a mutual fund in that it offers you a share in a basket of financial assets. These assets could be any form of financial assets ranging from stocks and bonds to forex, commodities and derivatives. Many ETF’s track major indexes so that they have the tradability of a stock but the investment diversification of an index .

ETF’s do not trade over the counter in the net asset value of their asset basket unlike mutual funds. Only so-called “authorised participants” may buy or sell directly from ETF’s and these are large financial institutions that trade in very large blocks. Individuals or small investors have necessarily to deal through a stock exchange. This also makes them convenient because, if a small investors had to invest in an index of say stocks, it would be next to impossible to impossible for him to buy up the shares that make up the index.

ETF versus stocks:

- if you wanted to buy a basket or pool of stocks, you would have to buy some quantities of each of the stocks that make up the pool. With an ETF, you only need to buy shares in the ETF just as you would buy any  ordinary stock

-ETF’s can be sold short or traded on margin just like stocks. You can also place limit orders.

- Unlike a stock, where you are dependent on the fortunes of a single company, an ETF represents automatic diversification of risk since you are investing in a portfolio.

ETF versus index

-ETF’s are often co-related to an index and designed to mimic the performance of the index. For instance, the OIH is an oil industry ETF that follows the performance of the OSX index (which is itself made up of a number of oil industry shares). So if you would like a well-balanced portfolio investment in the oil industry, you would buy OIH instead of all the shares that make up the OSX  index

ETF versus mutual funds

-an ETF combines the basis of valuation (net asset value) of an open-ended mutual fund with the tradability of a closed ended mutual fund which trades throughout the day on a stock exchange.

-because ETFs tend to be passively managed, their costs are much lower than mutual funds which tend to be actively managed. They do not need to enter the marketing and distribution costs as well as the research costs of mutual funds. Investors will find ETFs cheaper than mutual fund funds because of this.

As we asked at the beginning of this article, are ETF’s  really the best of all worlds? They are not perfect investments but, because of their advantages and techniques like ETF Trend Trading, you should certainly take a serious look at adding them to your investment portfolio.