Exchange traded funds (ETFs) can best be compared to mutual funds. Mutual funds are generally a group of stocks that allow an investor to buy into a particular area of the stock market. A fund might follow an index of stocks such as the Standard & Poor’s 500 or the Dow Jones Industrials. It could follow a particular sector of the market such as real estate, energy, bonds, or commodities. It might concentrate on large cap stocks or small cap stocks.
This basket of stocks is created and run by a fund manager. Some funds trade more actively than others, changing their positions frequently. Mutual funds generally charge fees and require a minimum investment to participate. Entering and leaving a fund is not an easy or quick proposition.
An ETF, on the other hand, can be traded in the same manner as any individual stock. There are no minimum investments. ETFs can be bought and sold at any time. Because of the ability to make small investments and buy and sell quickly and easily, an investor can gain exposure to many different segments of the stock market (or other markets) without the tedious work of selecting individual stocks.
Through ETFs, one can get exposure to the housing market, bonds, pharmaceuticals, high tech, commodities and energy, to name just a few. Today there are gold and silver ETFs as well as an ability to trade in foreign markets, including foreign currencies. To try to invest in even three or four segments of the stock market by choosing a portfolio made up entirely of individual company stocks can be time-consuming and nerve-wracking. While a savvy investor will have a number of individual stocks in her portfolio, ETFs allow one to search out a sector that is doing well and take advantage of it without having to do the time-consuming work of investigating dozens of stocks.
One can take some profit from an ETF just as quickly and easily as selling any stock, paying only your broker fees. ETFs behave just like stocks in terms of taxes as well. No taxes are due until profits are taken.
In short, if you don’t have the time or the resources to investigate individual companies, you can look for a sector that seems to be on the way up and buy shares in an ETF that follows that sector. You can find lists of ETFs on-line and compare their actual success over the past months and years just as you could any individual stock. Find out what’s hot and give an ETF or two a try. It’s an easy way to diversify and a relatively safe way to invest.