What Exactly Is An ETF?

September 29th, 2010

How do I go about choosing a good ETF?
An ETF is an Exchange Traded Fund and it is a member of exchange-traded product-family (ETP). It is basically an investment fund which is traded on stock exchanges, much like stocks. An ETF holds assets such as stocks, commodities or bonds and trades at approximately the same price as the net asset value of its underlying assets over the course of the trading day. ETFs may be attractive as investments because of their low costs, tax efficiency and stock-like features. ETFs are mutual-fund-like investments, which allow you to invest in a number of stocks by buying shares of a single fund. The best ETFs are those that fit your investment goals

ETF is subject to opinion.
Of course no two investors will agree about which are the best ETFs. Some investors might think a good ETF is one that has a higher than average dividend yield. Other investors might think a good ETF is one that’s exposed to a high-growth industry such as clean energy. Still others might think a good ETF is one that invests in companies that sell goods and services to fast developing countries. With that said, there are some common characteristics you can look for.

Management fees
Look for relatively low expense ratios or management fees. These fees are what you’re charged every year to own the ETF. Since ETFs are generally passively managed funds, fees are especially important. They eat into your returns. The lower the fee, the better. Some types of ETFs charge more than others because of the nature of the stocks they own. That’s why is important to compare one ETF’s expenses to fees charged by similar ETFs.

Premiums and discounts
Look for small premium or discount. The price of an ETF should be close to the value of the stocks it owns. But that’s not always the case. Sometimes the price of an ETF is driven higher than the value of its holdings; that is, it’s selling for a premium. Similarly, the share price of an ETF can be pushed below the value of the stocks it owns. In that case it’s selling at a discount. As an investor, you want the premium or discount to be small, an indication that the ETF is being traded efficiently.

Active trading
Look for an active ETF. Even if you’re not a day trader, you want to see lots of trading activity in your ETF. If shares of the ETF you own are changing hands frequently, you have a better chance of getting the best price when you want to buy or sell. You also want to make sure your ETF will survive the inevitable weeding out process for new ETFs.

Where to look?
How do you find ETFs that meet these criteria? You can easily find ETFs with these and other desirable traits using various ETF screeners offered by the financial advisory services and the newspapers.

This entry was posted on Wednesday, September 29th, 2010 at 6:53 am and is filed under Economy, Finance, Personal / Internet. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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