An Exchange Traded Fund is a relatively new type of fund which is similar to a mutual fund that can be traded in an exchange similar to stocks. These are techniques created for the purpose of tracking underlying security. In fact, ETF may now track almost every type of security from a commodity or group of assets to index.
Types of ETFs
An Exchange Traded Fund may be divided into several types. If an ETF is designed for tracking bond market indexes, it is called a fixed-income ETF and works similar to an equity ETF in that it is tax efficient, lower in cost, flexible and transparent. Housing ETF, on the other hand, tracks performance of homes while real estate ETF are for real estate properties. Finally, there is also the healthcare ETF covering a diversified sector from pharmaceutical companies and medical equipment makers to hospitals and health insurance providers.
Because fixed income ETF, housing ETF, real estate ETF and healthcare ETF are similar to mutual funds which are essentially a group or number of stocks bundled into one investment product, only large financial management institutions have the power to create exchange traded fund. This is based on the Securities and Exchange Commission rules. The process of creating these funds involve careful and detailed planning by the company regarding the fees, number of shares and assets to be included. Then, the plan must be examined by the SEC before approving it on the market index. Exchange Traded Funds always sell shares in huge quantities which is the reason why most participants are also other huge investment firms though anyone is allowed to participate in investing in the funds.
Benefits of ETFs
Exchange-traded funds offer a lot of advantages or benefits to traders and investors on the index market. In comparison to individual stocks or mutual funds itself, it is quite a popular choice for big time investors as it allows a purchase of a number of assets in a single time and are more flexible. Because it may be purchased in a single transaction, there is a lower commission rate as there are no load fees and decreased managing fees. ETFs are, therefore, more cost effective on the part of the investor. An investor may choose to trade a housing ETF, real estate ETF, healthcare ETF or fixed income ETF whenever he or she chooses instead of waiting until the markets close. Therefore, buying and selling ETFs may be done quickly throughout a single trading day or whenever there is a shift in the market value.
As opposed to a traditional mutual fund, an exchange-traded fund has lower capital gain taxes because of the different design of the trade itself. Capital gains are not realized individually and are instead incurred after the assets and the entire fund are sold. Another characteristic of ETFs is that they have low turnovers due to the unique trade structure which allows redemption of the stocks being tracked, thus minimizing tax implications for the investor. Not only do ETFs have tax advantages but also have ease with risk management as these funds list options and future contracts. There is also a great deal of transparency and accountability with exchange-traded funds as the firms which have created or designed it are required to publish a daily list of assets that they have included in the funds. Finally, ETFs are actually quite easy to learn as the structure is designed in a very simple manner. As with all types of investments though, ETFs can only be understood with careful planning and useful experience.