Exchange Traded Funds

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Send the authors a comment or suggestion please include a discussion of the tax advantages and efficiencies unique to etfs [Dismiss] [Done] top down pros and cons between mutual funds and ETFs will be helpful to individual investors. Th... more [Dismiss] [Done] See All Suggestions

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Many ETFs have the key benefit of relatively low expense ratios. Because ETFs follow a set of predetermined rules, there is no research team or expensive fund manager to pay to make active decisions about the contents of the fund. Thus, ETFs are "passively managed" funds.

Another benefit of ETF's is that they are much more portable than most mutual funds. Portability allows an individual investor to switch financial advisors without incurring the tax cost and transaction costs of selling and buying proprietary mutual funds. Practically all advisor platforms handle ETFs since they trade identically to individual stocks.

[edit] Accessing International Markets through ETFs

ETFs can be an excellent way for US-based investors to diversity internationally. Many mutual funds are benchmarked against similar US indexes. For example, Dodge and Cox International Stock fund (DODFX) is a five-star rated fund because of its strong performance. Indeed, when measured against US index like the S&P 500 or even large value funds like the Russell 1000 Value Index (the iShares tracker is ticker symbol IWD), DODFX shines handsomely.

However, compare DODFX to an international index like the MSCI EAFE Index, which can be loosely interpreted as an "international" (i.e., non-US) S&P 500-style index. Chart DODFX, a five-star rated fund against EFA, the iShares tracker for this international index, and the result is a near perfect correlation. The expense ratio on DODFX is 0.66%, whereas the expense ratio on EFA, the index tracker exchange traded fund, is a low 0.34%. VEA, the Vanguard international index, bears a mere 0.15% expense ratio.

(Note the bid-ask spread on your ETF at purchase: long-term investors can focus on the expense ratio alone, whereas actively trading investors may wish to consider the premium they're paying for a less-liquid ETF like VEA versus the well-known EFA)

Thus, rather than paying the inherent costs of an actively managed fund, investors can consider a much less expensive index-tracking international ETF to benefit from market conditions that favor international equities, like a weak US dollar. In reality, the expensive analyst teams managing many five-star international funds seem only able to stay in line with appropriate benchmarks, rarely actually exceeding them.

Of course, by using ETFs to access international equities, investors also gain the flexibility of using these freely traded securities, to enter and exit the international markets at times when they aren't open. There are hidden costs associated with this "artificial" liquidity that are built into the cost of the ETF share itself.

Finally, US investors are able to enter and exit positions in international equities using only US dollars. There are no conversion fees incurred by first trading currency into the local market currency before investing. Regardless of the currency used for the underlying basket of international equities, the ETF is priced in US dollars.

[edit] Commodity ETFS

Commodities ETFs hold a commodity as their underlying asset, allowing an investor to invest in the commodity. For example, a gold ETF would have physical stockpiles of gold proportional to the value of its outstanding shares. One of the first commodity ETFS was StreetTracks (now SPDRs) Gold Shares (GLD) which tracks the price of gold, first listed in 2004.

Several ETF fund families such as PowerShares, Adelante Shares and Currency Shares have brought out shares which correlate to the price of individual commodities or baskets, such as the PowerShares DB Agricultural Fund (DBA) which reflects the prices of four of the most widely traded agricultural commodities: corn, wheat, soybeans and sugar.

Other commodity ETFs are linked to the prices of base metals, energy products including crude oil and gasoline, livestock, and the performance of various world currencies against the US Dollar.

Commodity ETFS represent significant opportunities for the stock market investor. They can provide liquidity and portfolio diversification into physical assets once only accessible in the futures markets without margin requirements and leverage.