Recall that as we grow our portfolio, we never want all our eggs in one basket. In today’s article, I’m going to be discussing another investment product available to you known as an ETF or exchanged traded fund. An exchange-traded fund is simply a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. In my previous article, The 15 Trillion Dollar Lie, I talked about how mutual funds are attractive because they provide you with instant diversification. The fund is composed of a group of assets, such as stocks, that work together as an aggregate to form a price. Recall that mutual funds prices are only calculated once per day and they are only able to be traded at the end of the trading day.
Etfs are known as a hybrid type of investment because they provide the instant diversification across different assets like mutual funds and also trade intra-day just like stocks. When you buy an etf you are spreading your risk out among the basket of assets within the fund and they are fully liquid to be traded during the day. That basket of funds could be the following:
Indexes: These etfs track as certain index such as the Dow Jones, S&P 500, Russel 1000, Nasdaq, and even foreign markets such as the Nikkei 225. The most popular etf in this category are DIA (Dow Jones etf) and SPY (S&P500) etf. These etfs allow you to go long (buy) an entire index.
Commodities: These etfs track commodities such as Gold, Silver, Oil, Wheat, Corn, Coffee, you name it. This allows investors to have a stake in the market for these commodities without going out and buying the physical product. (You don’t have to buy gold bars to own gold.)
Bonds: These etfs track a basket of bonds. Bonds themselves will be talked about in another lesson but for now just now that bonds can be issued by companies or the government. It’s a debt instrument that has a set interest payment and maturity date. Some of the most common you will hear about are the 5, 10, and 30-year U.S. Treasury bonds.
Currencies: These etfs track a certain currency such as the US dollar, British Pound, or Japanese yen.
Equities: These etfs track a group of stocks. Sometimes these can be custom made with a variety of different stocks picked by the fund manager and other times it can be encompassed with funds of a certain industry such as consumer goods or healthcare.
Real Estate: These etfs involve a basket of real estate properties such as apartments, condos, and houses of a certain area. This is a good way to invest in real estate market without having to put up hundreds of thousands for a property.
As a hybrid product, etfs provide you the best of both worlds when it comes to an investment product. You receive the instant diversification such as a mutual fund and you can also buy/sell the product all day long just like a stock. The price at which you will buy and sell a mutual fund is often unknown because they are only calculated once per day. With an etf you know exactly what price you will be getting.
- Ability to Invest in a Variety of Products
Etfs provide you with the ability to tap into a number of products such as commodities, currencies, and real estate without actually buying any physical products. A typical question I get asked is how to invest in gold or silver. Etfs are the answer!
- Lower Fees
Mutual funds can be loaded with fees from the fund manager that are directly passed on to investors. Etfs have much lower expense ratios for the diversification you are receiving.
Personally, I would invest in an etf over a mutual fund any day! The advantages make it a better product and they also allow you to diversity your portfolio in a variety of ways. Recall in the article, Investment Tips We Can Learn from Pablo Escobar, as we grow our portfolio we want to diversify across different assets classes to spread out our risk. These investments include products such as commodities and bonds in addition to our stock positions. Etfs give you the ability to invest in these products without paying enormous fees.
Homework: Look up one etf in each of the category I provided. Find its ticker symbol and look at charts to see how it has been performing lately.