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Growth Products: ETFs
 

All About Exchange-Traded Funds

What’s an ETF?

ETFs came about in 1993 with the launch of the S&P 500 Depositary
Receipts (SPY) by State Street Global Advisors. ETFs are bought and sold throughout the trading day just like stocks. Their price changes instantaneously, whereas mutual funds are priced at the end of the day. Also, becausemost ETFs mirror an index, they are passively managed and therefore have lower expense fees (no loads, either, like many mutual funds). You can trade ETFs using market, limit, and stop-loss orders. Finally,
there is no minimum for ETF purchases. In short, ETFs offer the diversification
advantages of mutual funds and the flexibility of stocks.

Advantages of ETFs: Let’s now examine the advantages ETFs offer in more detail.

Diversification
One of the greatest benefits of trading ETFs is that they are similar to mutual funds in that you are invested in more than one company. If you have a bullish opinion of the oil sector, for example, you would have to choose among dozens of companies within that sector. You could spend hours analyzing those stocks to select the one you feel is the strongest. But regardless of your analytical skills, your chosen stock could be hurt by a poor earnings report, an analyst downgrade, or a management scandal. The ability to diversify has always been one of the biggest selling points for mutual funds. But mutual funds have their limitations, as we describe throughout this report.

Liquidity
One of the biggest disadvantages of mutual funds is that they are priced just once, after the closing bell. So you can’t get into or out of them during the trading day. You’re unable to take advantage of big up or down days until after the move happens. This
inability to move in and out of mutual funds can cost you several percentage points, and it is not very conducive to short- or intermediate-term trading. For example, those who were holding oil-related mutual funds during the major downdraft in oil prices in early January 2007 had to watch helplessly as intraday prices fell off the table. They simply had to wait for the end-of-day settlement prices. But OIH holders could have sold any time during the downdraft. On January 3, 2007, OIH dropped 4.3 percent. Would you rather be forced to absorb that entire loss or have the flexibility to cut your loss at your discretion? That’s a key advantage that ETFs hold over mutual funds.

Low Expenses
Another major advantage of ETFs versus mutual funds is the fees charged by each. EFTs have a lower expense ratio.

Tax Advantage
ETFs offer tax advantages over mutual funds because of the way they are structured. ETFs don't have to sell underlying securities to meet redemptions, because shareholders sell their shares to others. ETFs may have to periodically pay out distributions as their underlying benchmarks change. But such distributions are generally far less frequent than with traditional mutual funds.

Portfolio Transparency
ETFs list their holdings and the weighting of the holdings for all to see. This allows investors to know exactly what they are buying (or holding).

Options Available
One final benefit worth mentioning is the fact that most ETFs, unlike mutual funds, have options available. This opens up a whole new dimension of trading that allows hedging and leveraging of an ETF position. All of the option strategies available to stock traders are open to ETFs as well, including more advanced spread trading.

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Phone : (718) 674-2291 E-mail: info@gospichadvisors.com