This post was authored by Steve Skalka.
Exchange-Traded Funds (ETFs) have rapidly grown in popularity over the last several years. Today it is difficult to read an investment publication or tune into a financial television channel without being exposed to ETFs in some way, shape or form. In spite of all of this visibility and rapid popularity, many investors remain unsure of what ETFs are and how they work.
What exactly are ETFs?
ETFs are investments that offer investors an undivided interest in a pool of securities and/or other assets and thus are similar to mutual funds. ETFs traditionally have been designed to track the performance of particular indices, but in 2008 the U.S. Securities and Exchange Commission began to authorize the creation of actively managed ETFs. This led to a broad expansion of ETFs into areas such as commodities and currencies.
How do ETFs differ from mutual funds?
The primary difference between ETFs and mutual funds is the manner in which they trade. ETFs offer greater flexibility than mutual funds when it comes to trading. In the case of mutual funds, purchases and sales take place directly between investors and the mutual fund. The price of the mutual fund is not determined until the end of the business day, when net asset value is determined.
An ETF, by comparison, is created or redeemed in large lots by institutional investors, and shares trade throughout the day among investors, like a stock would. Since shares of ETFs are traded like stock, investors enjoy the benefit of being able to trade ETFs throughout the day. In addition, as publicly traded securities, ETF shares can be purchased on margin and sold short, enabling the use of hedging strategies. ETFs can also be traded using stop-orders and limit-orders, which allow investors to specify the price at which they are willing to trade.
What are some of the benefits of ETFs?
Investors are increasingly drawn to the benefits that ETFs provide. Some of the benefits that ETFs offer include the following:
- Transparency. ETFs report their holdings on a daily basis, which allows investors to regularly see the underlying assets behind each ETF share.
- Flexibility. ETFs offer flexibility, allowing investors to buy and sell shares throughout the day.
- Improved Diversification. When an investor purchases a share of an ETF they gain exposure to a multitude of underlying securities. ETFs provide this exposure in a single package, making it possible to obtain diversification with smaller sums of money.
- Trade at or Near Net Asset Value. ETFs generally trade at or near the value of the holdings that comprise each fund; meaning that market speculation generally won’t drive the price of an ETF.
- Attractive Fee Structure. ETFs oftentimes provide low ownership costs because of their efficient structure.
At Horizon Bank, we believe that ETFs will continue to gain in popularity and are more than just a passing fad. ETFs have made it possible for the average investor to gain exposure to asset classes that just a few years ago were limited to investors who were able to meet the high minimum investment thresholds that corresponded to many of these asset classes. ETFs have played a vital role in opening these asset classes to all investors. This in turn assists us in building more diversified portfolios for our clients.
If you have additional questions regarding ETFs, please contact your Horizon Bank Relationship Manager. We would be happy to discuss ETFs in greater detail and let you know how we are currently utilizing them within our portfolios.