Exchange Traded Funds

Exchange Traded Funds

Exchange traded fund (ETF) is one of the most important investment and valuable product that provides investors a way to pool their money in a fund. This marketable security makes investments in common stocks, bonds or a basket full of assets like an index fund and in return receives an interest in that investment. Worldwide, ETF’s have opened a whole new landscape of investment opportunities to retail as well as institutional Money Managers.

They allow investors to increase the exposure to entire stock markets in different countries on a real time basis and at lower cost than other investments forms. Exchange traded funds experience price changes all through the day as they are bought and sold. Distinct from mutual funds, ETFs’ shares are traded on a national stock exchange and a mutual fund that has its net asset value calculated at the end of each trading day and on the other side an ETF’s price changes throughout the day, fluctuating with supply and demand.

Though, ETFs are different from mutual funds. Moreover, the innovative ETF structure allows investors to short markets, to gain leverage and to avoid short-term capital gains taxes. There are various types of ETFs such as Commodity ETFs, Market ETFs, Sector and Industry ETFs, Bond ETFs, Foreign market ETFs, inverse ETFs and many more.

What is ETF
What is ETF

There are lots of benefits of ETFs:

1) You can buy and sell any time of the day.

2) ETF shareholders don’t need to pay for a manager and do not carry brokerage commission to buy or sell funds, nor to manage fund inflows and outflows, there is no sales load, thus, exchange traded funds have much lower fees.

3) ETFs tend to be very tax efficient as the Investors have better control over when they pay capital gains tax

4) The ETFs are traded like stocks, investors can put various types of orders (stop-loss order, limit order, buy on margin) which are not possible with mutual funds.

Disadvantages of ETFs:

1) Each time when an investor place an order to buy or sell an ETF then he/she will need to pay a trading fee just similar to when a stock is traded

2) If you compare ETFs to investing in a specific stock then costs are actually higher, but most of the people compare trading ETFs with other stocks as mutual funds which is different.

3) Some niche traded ETFs have a high bid or ask spreads which means either you will be buying at the high price of the spread or selling at the lowest price of the spread. You may find a better price investing in the actual stocks or maybe even a managed fund.

How do ETFs work?

There are two concepts to understand, How ETFs work?

First, creation and redemption which is the process by which ETFs are bundled and second, the role of Authorized Participants (APs) are two concepts that enable ETFs’ intraday liquidity. Creation and redemption are the procedure by which ETF’s are packaged or collected and deconstructed and authorized participants are usually large institutional investors that create and redeem the baskets of securities. These market makers play a vital role to supply liquidity and keeping ETF prices aligned with the market value of the core assets all through the trading day.

When the increase in demand causes the price of an ETF to trade higher than the value of the ETF holdings, the role of Authorized participants is to buy the underlying securities and exchange them for ETF shares and then sell those shares into the market. In opposition, if the  decrease in demand causes ETF prices to trade too low, i.e., at a discount, an AP may purchase shares of the ETF in the market and redeem shares in exchange for the underlying securities.

Whether it’s a mutual fund or an ETF, the value of the joint security also increases, when the value of the underlying securities increases. Thus, this process helps to keep ETF prices close to the market value of the underlying securities,”

Four important things to know about ETFs:

1) How an ETF has executed in the past cannot tell you how it will perform in the near future. But on the basis of the past performance it will help you to determine how risky the ETF’s returns may be.

2) The level of risk and the return based on what the ETF invests in. You can lose money investing in ETFs.

3) Typically, you pay commissions and management related fees to invest in ETFs. It may also include costs to set up an investment account.

4) You purchase and sell ETFs on a stock exchange, in a same way to buying and selling stocks.

ETF’s are outstanding vehicles for getting experience into gold and precious metals related to specific countries or specific industries. ETFs are suited best for the investors who aim to hold them for a long period.

Thus, “All investment in knowledge pays the best interest”

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