Market Beat: Understanding exchange traded funds
October 28, 2011
TRUCKEE, Calif. andamp;#8212; Since the first exchange traded fund, or ETF, came onto the market in the late 1990s, there has been an explosion in the number and variety of ETFs available for purchase. Currently there are more than 900 ETFs. ETFs provide a real advantage to investors because they are very simple to trade, most have low expense ratios and they can give an investor the ability to diversify like never before.The difference between an exchange traded fund and a traditional mutual fund is that the ETF trades throughout the day on an exchange. An open-end fund only trades at the closing price at the end of the day. If an investor purchases shares in an open fund, the fund will create new shares for that purchase. If an investor liquidates fund holdings, the transaction occurs at the end of the day price and the fund can decrease the total number of shares.The transaction goes through at the NAV or net asset value of the fund. One disadvantage of the open-end fund is that the fund can decline quite a bit in one day from the time the investor makes the sell decision to the time it is executed. With an ETF, the investor gets the current price without having to wait for the end of the day.With relatively small amounts of money, investors can diversify into various markets including equity indexes, fixed income indexes, commodities and currencies. Today, more than one fourth of all equity trades are done with ETFs, and the four equities with the highest trading volume are ETFs.There are several factors to be considered when purchasing an ETF. The expense ratio is one, but you also have to look at the total expenses, including trading costs and tracking error. Tracking error is the difference between the fund’s actual performance and the performance of the underlying index. Many of the major discount brokerages now offer commission free ETF trading for certain funds; check with your broker to see which funds are eligible for commission free trading.Kenneth Roberts, a Truckee-based Registered Investment Advisor, has been in the securities business since 1992, has worked as a branch manager for a major Wall Street firm and is currently a portfolio manager for Fusion Asset Management. Information on his money management service can be found at http://www.fusiontargetretirement.com or by calling 775-675-8065. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.