One of the most talked about financial investment products today is the ETF, but most people really have no clue what these are or if they are beneficial to them as an average investor.
An ETF is an ‘exchange traded fund’, but the full name really is an ‘exchange traded mutual fund.’
So in most respects these are just mutual funds that track an index such as the S&P 500.
ETFs vs. Mutual Funds
Here are some key facts and the highlights of what the difference actually is between an ETF and a mutual fund:
- An ETF can be traded during the day and there are price fluctuations throughout the day, unlike a mutual fund that is available to be purchased and valued only one time each day.
- Unlike many mutual funds that have large minimum initial purchase requirements, an ETF can be bought in increments of single shares. They are subject to commissions similar to regular stocks, but Charles Schwab and Fidelity both have a range of commission-free ETFs available, so you’re able to purchase small quantities on a regular basis.
- An ETF does not try to outperform whatever index it is tracking, it merely attempts to match that index as closely as possible.
- An ETF is more tax efficient than a mutual fund as there are significantly fewer transactions internally that would lead to capital gains tax passed through to the shareholder.
- Since an ETF does not need active management to track and index, the administrative costs and expense ratios are much smaller than a mutual fund. Sometimes as low as .05%, which is incredibly small.
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It’s definitely worth highlighting the affordable cost on these financial instruments. One thing the average investor (advanced alike) needs to be careful with are the exotic ETFs, by that I mean those that are covering more advanced and esoteric topics. ETFs that cover rare precious metals or a specific geography are much more likely to have a higher fee. In comparison, an ETF like GLD, which tracks gold is much more affordable.
One more consideration for the readers has to do with trading volume. ETFs rarely have large price swings, except for those with low trading volume. An ETF like SOCL, one that tracks social media companies may have huge gaps in the buy/sell because it does not get traded as much as something like GLD.
Just thought I would add a few of my own opinion.
Scott @ Youthfulinvestor.com recently posted…The Best Investing Blogs for College Students and Twenty-Somethings
Scott,
That is an extremely valuable comment — I really appreciate you passing it along.
I sometimes get locked into my own thinking and in a case like this fail to pass along pertinent information; I personally would almost never invest in these “exotic” ETFs, but I know many people would, so it is important they are armed with all the facts.
Thanks and I’m looking forward to visiting your site…
I found this site that helps quickly analyze 3 funds at a time (with regards to fees and sales charges). It is a great way to see how over time, your investment can go a lot farther with low fee EFT’s (such as vanguard)– let me know what you think.
http://apps.finra.org/fundanalyzer/1/fa.aspx