What is an ETF?
An ETF is an Exchange Traded Fund. ETFs are similar in many ways to traditional mutual funds, except that shares in an ETF can be bought and sold throughout the day like stocks on a stock exchange through a broker-dealer. An ETF holds assets such as stocks, commodities or bonds. It trades throughout the day at a market price that approximates the net asset value of the underlying assets. Most ETFs track an index, such as a stock index or bond index. So, in short, an ETF is like a mutual fund, but it trades like an individual stock.
How do ETFs and mutual funds differ?
The main differences between ETFs and mutual funds are costs, trading and tax efficiency. Let’s take a brief look at each.
Costs: ETFs have a reputation for lower costs than traditional mutual funds. Since most ETFs are index funds, they are much simpler to run, since it does not require some security selection, and can be largely done by computer. Mutual funds can charge 1% to 3% or more while ETFs are almost always less than 1%.
Trading: A mutual fund is bought or sold at the end of a day’s trading, whereas ETFs can be traded whenever the market is open. Since ETFs trade on the market, investors can carry out the same types of trades that they can with a stock. For example, investors can sell short, use a limit order, use a stop-loss order, buy on margin, and invest as much or as little money as they wish.
Taxes: You may know that whenever a mutual fund realizes a capital gain that is not balanced by a realized loss, the mutual fund must distribute the capital gains to its shareholders. ETFs on the other hand generally only realize capital gains when they sell their own shares or when the ETF trades to reflect changes in the underlying index.
What are ETNs?
An ETN is an Exchange Traded Note. ETNs are unsecured debt obligations of financial institutions that trade on a securities exchange. ETN payment terms are linked to the performance of a reference index or benchmark. For example, they might be linked to well-known broad-based securities indexes or based on indexes tied to emerging markets, commodities, volatility, a specific industry sector (e.g. oil and gas pipelines), foreign currencies, or other assets.
ETNs are more complex than ETFs and include higher levels of risk. The SEC notes that “You should understand that ETNs are complex and involve many risks for interested investors, and can result in the loss of your entire investment.”
Does Guidepost Financial Planning like ETFs or ETNs?
In general, we like ETFs, but are cautious regarding ETNs. For both types of securities, you should ensure the fund has sufficient volume (high volume is good, as spreads and trade execution are better) as well as reasonable costs. As with all investments, your personal situation and objectives are central factors. We’d be happy to sit down with you and discuss ETFs and investments generally in a no-charge, no-obligation initial meeting. Just visit our website or give us a call at 970.419.8212 to learn more.
This article is for informational purposes only. This website does not provide tax or investment advice, nor is it an offer or solicitation of any kind to buy or sell any investment products. Please consult your tax or investment advisor for specific advice.