What is an ETF and how do they work?

ETF stands for exchange traded fund. An exchange traded fund is a an investment product that aims to track a particular market like the Dow Jones or oil.

The ETFs often buy a basket of securities to enable the fund to track the underlying index.

ETFs can be traded by both large institutions right the way down to the individual investor.

ETFs can be bought just like normal stocks.

Is an ETF different to a mutual fund?

Yes, there are many differences including:

Prices change throughout the day, where the price mutual funds only changes at the end of the day.

ETFs can often be sold short, whilst this is not the case for mutual funds.

ETFs can be bought on margin.

Each ETF trade incurs a trading commission like when you stocks.

What are the advantages of ETFs?

More Cost Effective

One of the major advantages is the management fees are usually a great deal less than those of a actively managed mutual fund. Typically management fees for an exchange traded fund are less than 1/3 of those for a mutual fund.

Mutual Funds often charge a management fee as well as a startup fee!

Easier to manage

As exchange traded funds are traded just like stocks, it is easy to get real time valuations of your trades. It is also very easy to have all your ETF trades through one broker.

Tax Benefits

One of the biggest appeals of exchange traded funds is their tax benefits. ETFs only incur capital gains tax when the fund is sold.

Mutual funds incur captial gains tax on unrealized profits throughout the life of the investment.

Transferability

Exchange traded funds are much more portable than mutual funds.

It is not uncommon for complications to arise when trying to trying to move mutual funds to a different broker.

Sometimes the fund positions have to be closed and reopened with the new broker. This can incur a additional mass of fees and commissions and depending on your jurisdiction, may impose early capital gains tax.

In most cases an ETF can be easily moved to a different broker without any such hassles.

Immediate Dividends

With exchange traded funds, dividends are usually immediately invested back into the fund. Time frames with mutual funds can vary greatly.

Ability to go short

Exchange traded funds allow you to go short as well as long. So if you predict there is going to be a stock market crash, you can easily short the Dow Jones Industrial Average or another stock index.

Which instruments can be traded using ETFs?

Nowadays, there is an exchange traded fund for just about every instrument imaginable including currencies, metals, oil, gas, stock indices, grains, milk, orange juice, bonds and many many more.
Are ETFs right for you?

Exchange traded funds are not suitable for everyone. They can be very risky as ETFs can fluctuate massively in small periods of time.