An exchange-traded funds (ETF) is an investment fund that can be traded like stocks. With a background of a basket of securities like stocks, commodities, etc, are traded on the Exchange. An ETF is unlike most mutual funds because the units can be bought can be bought and sold directly on the exchange through a stockbroker during trading hours.
Exchange traded funds are advantageous for asset diversification for an investor. They also provide the low expense ratios and tax efficiency of index funds. Although they still maintain the features of ordinary stock like short selling and options. They are mostly used as long-term investments for asset allocation purposes and are helpful in implementing market timing investment strategies.
Most ETF’s are not actively managed which accounts for their generally lower costs as compared to other investment options. They are also insulated from the costs of buying and selling securities to accommodate the purchases and redemptions of shareholders. This accounts for their tax efficiency which is further enhanced by the fact that ETF’s have low turnover of their portfolio securities.
Exchange traded funds are also flexible with regards to trading. They can be bought and sold at any time during the trading day at the current market price. This characteristic is unlike conventional mutual funds which can only be traded at the end of the trading day. They also enable the seasoned investor to purchase shares on a margin and short sell them to make a profit.
In addition to these properties, ETF’s also provide diversification across an entire index, which provides an economical way to rebalance one’s portfolio. Trading is also transparent as the units of the fund are priced at frequent intervals throughout the trading day.
With a Mutual fund the investor has to buy and sell units from the brokerage while in the case of an ETF the transaction is routed through a broker directly on the stock exchange. They are also involved in safeguarding the interests of long-term investors due to the fact that they are traded directly.
Investors will be especially to interact with other investors, ensuring that the fund manager is not obligated to sell to meet redemption pressures. This will happen in the case of collective investment where the possibility of a substantial issuer can not be excluded. This could have a negative impact on the interests of long-term investors.
ETF’s are often confused with conventional Mutual funds when in reality they are very different. The only similarity between ETF’s and Mutual Funds is that they provide investors the opportunity to invest in an assortment of instruments through a single avenue.