What is an ETF?
ETF stands for Exchange Traded Fund. The closest relative of the ETF is a mutual fund or the index fund. Each mutual fund, index fund, and ETF includes a sum of funds contributed by different investors.
There are different categories and types of ETF’s. There are actively managed ETF’s (like mutual funds) where people buy and sell stocks in order to get the best returns according to the goals of the specific ETF. There are also passive ETF’s (like index funds) where many shares are purchased in line with a market index so you will get the average return of the index. Actively managed ETF’s seek to beat the market (with the possibility of lagging the market returns). Passive funds are satisfied simply to mirror the market returns. In addition, there are sector ETF’s that track a certain sector of the market. Let’s assume you think that gold will perform well. You could buy an ETF that focuses on the gold market or even other precious metals.
The key difference between ETF’s and mutual funds is that ETF’s can be bought and sold just like stocks. That means that you can buy or sell the ETF during the day (just like a single stock). Mutual funds, on the other hand, can only be purchased at the end of a trading day.
What makes an ETF better or worse?
What makes an ETF better?
The most substantial advantage of an ETF over and above both mutual funds and index funds is that the minimums to purchase an ETF are much lower. If a new investor has $1,000, that is usually only enough to meet the minimums to purchase a couple of mutual funds or index funds. However, when buying ETF’s, the investor can easily diversify their investment amongst a dozen different ETF’s.
In comparison to mutual funds, ETF’s typically carry lower operating fees. Since less of your money is being spent on fees, you’ll have more dollars growing in the market. And that is good news for any investor.
What makes an ETF worse?
Many mutual fund buyers rely heavily on historical performance to determine the best fund. However, since ETF’s are relatively new, there is much less recent performance history. As such, it is harder to make an informed decision based on historic performance. Similarly, if you have a mutual fund manager you really like, you might not be able to find that level of experience in a comparable ETF.
At any time in the day ETF’s can be traded with ease. Some people see this as an advantage, and others see it as a disadvantage. The danger of being able to trade during the day is that investors are more likely to try and time the market and sell off during a low point in the trading day. These, of course, are costly investing decisions. For those without investing discipline, ETF’s could be dangerous.
If you are a passive investor who usually invests in index fund then it is quite possible that you could pay lower operating fees if you have a large amount of money invested in index funds instead of ETF’s. That completely depends on the company you use for index funds and for ETF’s.
For more information on the topic, you can read ETF, Mutual Fund, Index Funds Defined and Explained.
History of ETF Pricing
In 1993, the U.S. had its first listed ETF. Since then the EFT landscape has changed dramatically. One of the initial criticisms of the ETF was that it was a very expensive way to trade. Over the last year or so there has been a very positive trend amongst some of the largest online brokers. A pricing war of sorts is ongoing. And we, the customers, stand to benefit.
One of the key areas where online brokers have been competing is over the market share for Exchange Traded Funds (ETF’s).
This competition has left ETF traders with four viable options for getting free EFT trading.
Here’s the play by play:
- November 2009 – Charles Schwab starts offering their in-house ETF’s fee-free. At that time, Sound Mind Investing predicted “some might even adopt a similar commission-free model, opening the ETF door to millions of average investors who, until now, have seen ETF investing as too expensive.”
- February 2010 – Fidelity starts offering a batch of fee-free ETFs (some inhouse and some iShares).
- May 2010 – Vanguard begins offering their in-house ETF’s without a fee.
- October 2010 – TD Ameritrade joins the party and ups the anti by offering the largest selection of free ETF’s. Over 100 fee-free ETF’s are offered.
The USA Today claims that with ETF’s you can:
quickly, easily and inexpensively create diversified portfolios that they can hold long term, he says. “If you’re a long-term buy-and-hold person, chances are you’re now better off with ETF’s than competing mutual funds.”
People who have experience investing typically talk about using one of four investing methods – stocks, mutual funds, index funds, and exchange trade funds (ETF).
When ETF’s started to gain in popularity, there was some criticism that the disadvantage to consumers was the cost of buying and selling an ETF. However, with the current number of viable options for trading ETF’s without fees, most investors consider them to have an ever increasing appeal.
Where Can You Buy and Sell ETF’s Without Paying Trading Fees?
|Number of Fee-Free ETFs Offered||ETFs issued by||More information|
|TD Ameritrade||101||iShares, PowerShares, Vanguard||www.tdameritrade.com|
|Fidelity||26||Fidelity and iShares||www.fidelity.com|
While you do not pay any fees to buy and sell ETF’s at these brokers, you will pay ongoing operational fees. The fees will vary according to the ETF type so you’ll need to compare similar ETF’s with each other.
As a sample of operating fees, I’ve listed the fees associated with the free Charles Schwab ETFs:
- U.S. Broad Market ETF — from 0.08% to 0.06%
- U.S. Large-Cap Growth ETF — from 0.15% to 0.13%
- U.S. Large-Cap Value ETF — from 0.15% to 0.13%
- U.S. Small-Cap ETF — from 0.15% to 0.13%
- International Equity ETF — from 0.15% to 0.13%
- Emerging Markets Equity ETF — from 0.35% to 0.25%
If you are currently investing in the market or considering some new investments, it might be worth your while to seriously consider the benefits of investing via an ETF. Be sure that you know if an ETF is right for you. Don’t just invest in an ETF because others think it is a great way to invest.