ETF shares are usually created by an institutional investor, depositing a specified block of securities with the Exchange-Traded Fund. In return for this deposit, the institutional investor receives a fixed amount of ETF shares, some or all of which may be then sold on a stock exchange. The primary investment objective of an ETF is to achieve the same return as a particular market index. Like any other publicly traded company, ETFs also have ticker symbols. There are a number of different ETFs on the market at the moment, including SPDRs, sector SPDRs, HOLDRs, iShares and Diamonds. They are all passively managed, tracking a wide variety of sector-specific, country specific and broad-market indices.
Advantages
ETFs have a better trading flexibility versus traditional mutual funds, because you can buy and sell them at anytime during the course of the day and receive the price at the particular time it is sold or purchased. This means that you do not have to wait until the end of the day for the price of the sell or purchase. They can be sold short and bought on margin. They are often promoted as offering the benefits of index investing with greater trading flexibility when compared to mutual funds.
ETFs are significantly less expensive than the vast majority of mutual funds, in terms of the annual expenses charged to investors.
ETFs are more tax-efficient than most mutual funds; therefore, they may hold a special attraction for investors in taxable accounts. Because most trading in ETFs takes place between shareholders, the fund is shielded from any need to sell stocks that would result in capital-gain distributions for the remaining shareholders. In addition, investors with more than 50,000 shares can redeem their shares for the underlying stock rather than cash. This means that the gain or loss is deferred until the investor sells the distributed shares.
Disadvantage
ETFs may be less expensive in terms of annual expenses. One thing you should note is that you must pay commissions to buy or sell ETFs, just as you would for stock transactions. For those who trade frequently or invest regular sums of money, it may not be a cost effective investment.
Another disadvantage is that the price of an ETF share is actually a function of the supply and demand of that share. Subsequently, a share could always trade for less than the value of the underlying stock in represents. This, of course, would not be the best of situations if you were seeking to sell your ETF.
Are ETFs Right For You?
Clearly, ETFs might not be suitable for everyone even though ETFs have several advantages when compared to mutual funds. You should consider every advantage and disadvantage to help you determine what role, if any, they should play in your portfolio.
An Exchange-Traded Fund (ETF) is a security that tracks an index, a commodity or a basket of securities unified by a particular investing theme, such as, companies whose main business is biotech. An ETF is similar to an index mutual fund, but trades like a stock on an exchange. Thus an ETF experiences price changes throughout the day, as it is bought or sold. However, ETFs differ from traditional mutual funds in that their shares are issued, traded and redeemed.