| What is an ETF fund? | | | | Expense ratios |
| Exchange traded funds (ETFs) have only been | | | | Buying and selling fees |
| around since 1993, when the first ETF fund was | | | | ETFs - standard brokerage commission |
| introduced. That original ETF (SPY, by State | | | | Mutual funds - between 0 and 5% (on purchase) |
| Street Global Advisors), tracking the S&P 500 | | | | Management fees |
| index, is still one of the most popular ETFs today. | | | | ETFs tend to have a significantly lower expense |
| In recent years ETFs became increasingly popular | | | | ratio than mutual funds. |
| as an alternative to mutual funds. | | | | ETFs - annual fees of 0.2 - 1% |
| ETFs are low cost index funds that are listed and | | | | Mutual funds - 1-3% p.a. |
| trade on major stock exchanges, just like stocks. | | | | You would not believe how much this saving adds |
| They are made up of a basket of securities, | | | | up over the long term! |
| similarly to mutual funds. However, an ETF has its | | | | (Expense ratios of ETFs vary, so make sure to |
| own ticker symbol and can be bought and sold, | | | | check the fund prospectus.) |
| during market hours - like an individual stock - | | | | Often investors don't realize that costs play a |
| through your broker (including discount online | | | | huge role in reducing their returns. Commissions, |
| broker). (A standard brokerage commission to | | | | load fees, advisory fees, management fees, |
| buy or sell will apply.) | | | | taxes, etc... when added up, they will reduce |
| ETFs track a variety of stock, bond, commodity | | | | overall investment returns very significantly. |
| and currency indices. Some ETFs track the | | | | Tax advantages |
| performance of a broad index, (eg. the S&P 500 | | | | One often overlooked issue is the high amount of |
| or FTSE 100, etc); others are more narrowly | | | | taxable transactions in most mutual funds. |
| focused on a specific sector, company size, or | | | | Actively managed mutual funds have high |
| even a country or region. | | | | turnover of their portfolio, and more trades result |
| Why invest in ETFs? | | | | in additional taxation. (The tax is deducted from |
| ETFs have become increasingly popular with both | | | | the investors in the fund, even when they don't |
| individual and institutional investors, as well as | | | | sell their shares.) This, along with all the other |
| traders and other financial professionals. Despite | | | | costs and fees means a huge reduction in a fund's |
| the jump in investments into ETFs, they are still | | | | return. |
| small compared to the money invested in mutual | | | | ETFs are usually more tax efficient than mutual |
| funds. | | | | funds. They are generally designed to track |
| What are the main advantages of ETFs? | | | | benchmark indices, and as such make fewer |
| * low expenses | | | | trades. The low portfolio turnover reduces the |
| * tax efficiency | | | | frequency of tax gain distributions. |
| * diversification -> reduced risk | | | | (In the US, whenever a mutual fund realizes a |
| * transparency, trading flexibility and liquidity | | | | capital gain that is not balanced by a realized loss, |
| * instant, low cost exposure to global markets | | | | the fund must distribute capital gains to its |
| * exposure to specific sectors, industries, | | | | shareholders. These gains are subject to taxes, |
| investing styles etc | | | | even if you reinvest the distributions in more |
| * access to long/short strategies | | | | shares of the fund. ETF investors only realize |
| While mutual fund managers try to beat a | | | | capital gains when they sell their shares in the |
| benchmark index each year, ETFs aim to mirror it. | | | | ETF, when the ETF changes holdings in its |
| Which is not a bad thing considered that a vast | | | | underlying index or when stocks are removed |
| majority of fund managers under-perform the | | | | from and added to the index.) |
| market averages, and even top managers rarely | | | | So instead of looking at the reported pre-tax |
| sustain their excellent returns over time. Trying to | | | | returns of actively managed funds, compare |
| outperform the market - especially after fees - is | | | | after-tax returns of available investments before |
| difficult, and most managers don't succeed. | | | | you decide where to put your cash. |
| Most investors tend to be better off buying an | | | | (Note that US taxation of commodity ETFs varies |
| index ETF, which is low cost and will ultimately | | | | depending on their structure. Some commodity |
| outperform most active managers. | | | | ETFs own the physical commodity and are taxed |
| One of the most important decisions for an | | | | at a long term capital gains rate. Others use |
| investor is the right asset allocation for his | | | | futures contracts to gain their commodities |
| portfolio. ETFs are well suited here, allowing active | | | | exposure; these are taxed every year, even if |
| investors to easily adjust their asset allocation as | | | | you don't sell, at a hybrid rate - 60% of your |
| markets (and risks) change, increasing or cutting | | | | gains are taxed at the long term capital gains rate |
| exposures fast. | | | | and 40% are taxed as short term capital gains.) |
| Since ETFs trade on exchanges, you have the | | | | Please note that this is not meant as tax advice |
| advantage of the same types of trades (long, | | | | and may not be correct at the time of reading. |
| short) and orders (incl. limit, stop, stop loss, etc) | | | | Speak to your tax adviser before making any |
| as with an individual stock. You can also buy on | | | | investment decision. |
| margin. Many ETFs also have the capability for | | | | Who issues ETFs? |
| options (puts and calls) to be written against | | | | There are a number of companies providing ETFs. |
| them. | | | | Among the best known are Barclays Global |
| The diversification of most ETFs reduces | | | | Investors, Vanguard, State Street Global |
| investment risk. Every individual stock is only part | | | | Advisors, Fidelity Investments, Deutsche Bank, |
| of a basket; hence ETFs are less volatile than | | | | Credit Suisse, Lyxor, and many others. |
| individual stocks. | | | | We will look at the various types of ETFs |
| Importantly, there is no minimum investment | | | | available to investors, and the benefits and risks |
| requirement, so you can buy as much or as little | | | | associated with each of them, in part II and III of |
| as you wish. | | | | this ETF series. |