The Basics – What is an ETF?

What is an ETF? There are number of ways to invest in stocks in the market, and one popular choice is through Exchange Traded Funds (ETFs). This popularity is derived from being able to combine the features of mutual funds with those of trading stocks.

The similarity to mutual funds is that when you buy an ETF, it will generally have ownership of range of securities, such as stocks, bonds and also cash/currencies. This provides an easy means to generate diversification, similar to a mutual fund. The distinction from mutual funds is that you can trade ETFs just like a stock, choosing your buy and sell price, that includes selling immediately at the market price, and in not having to hold the fund for a certain number of days.

Advantages of ETF investing:
I commonly use ETFs in my investment strategies, as it provides me with an easy and relatively cheap way of achieving diversity. Additionally, ETFs often have lower management fees than mutual funds. However, my favorite thing about them is this ability to be traded like a stock, providing me with much greater control to realize gains or minimize losses. Here is a quick video from Investopdia describing these advantages inherent with ETF investments:

Disadvantages of ETF investing:
You also have to be careful with this ability to trade ETFs, as if you are not careful you can do a lot of churning in your account, which is constant buying and selling of funds. This may result in lots of fees and hence limited profits, as you typically have to pay a small amount each time you buy and sell the ETF in the discount brokerage account you are using, just like a stock (but unlike a no-load mutual fund). You can somewhat limit this loss of profit from buy/sell fees, as many discount brokers have a small number of certain ETFs that you can trade for free. However, these ETFs tend to be quite broad in their holdings, and so more useful for index-based investing where you are less concerned about selling (but at least you can buy them for free). These freely traded ETFs are not so useful for sector/industry investing, where you are trying to stay in the hot sectors of the market, and hence need to be buying and selling.