An exchange traded fund (ETF) is a basket of securities — such as stocks, bonds, currencies, or commodities — that can be bought and sold in a single trade on an exchange. It generally tracks the performance of an index, may charge less fees, and offer targeted exposure to a specific market segment, such as an asset class, geography, sector, or investment theme.
In essence, ETFs are funds that trade like stocks with the diversification benefits of mutual funds. In one trade, they may offer diversified, low-cost, transparent and tax-efficient exposure to companies across the globe. But unlike traditional mutual funds, which are priced once a day at the close of trading, ETFs are priced continuously throughout the trading day and can be bought or sold at any time — allowing investors to react to market conditions and news in real-time and to execute trades quickly and efficiently.
Understanding the benefits of ETFs is an important step toward determining whether ETFs can be an appropriate choice for your portfolio
ETFs generally track an index, offering exposure to a specific segment of the market such as:
Because most ETFs are passively managed, they typically have lower management fees and operating expenses compared to mutual funds. Transaction costs are minimized due to the low turnover of most ETFs and the indexes they track. When fees and expenses are low, investors can keep more of their returns.
ETFs provide one of the easiest ways to diversify a portfolio.
They provide access to many companies or investments in a single trade, removing single stock risk — the risk inherent in being exposed to just one company. The ETF structure helps to lower the risk that a select number of individual stocks could hurt overall portfolio performance.
ETFs benefit from two sources of liquidity:
ETFs are generally more tax efficient than other investment vehicles due to the ability to transfer securities in and out of the portfolio in the most tax-efficient manner, via the in-kind creation/redemption process. Because ETFs generally track market indexes, turnover is generally low, resulting in fewer capital gains and lower taxes. Additionally, any associated capital gains taxes are paid at the time of final sale, offering greater control on the timing of tax consequences.
ETFs can be bought through an online brokerage account at their current market price, at any time during the trading day. There are no minimum holding periods, and investors can employ a wide range of trading techniques — such as buying on margin, short selling, and placing limit orders — to react to market movements.
Most ETF holdings are fully transparent and available daily, which means that investors can see exactly what assets the ETF holds and how its performance is being impacted by changes in the underlying assets. This can help investors make more informed investment decisions with greater accuracy.
Like any investment, ETFs carry certain risks that investors should be aware of before making a decision to invest:
Using a due diligence process, investors should consider their investment objectives and risk tolerance before investing in ETFs. Be sure to visit the fund’s prospectus for more information on the risks associated with a particular ETF.
One example of an ETF is the SPDR® S&P 500® ETF (SPY) — the largest,2 most traded,3 and most liquid ETF in the world.4 This ETF tracks the S&P 500 Index, which is a broad-based index that consists of 500 of the largest publicly traded firms in the United States, spanning all major sectors. By investing in SPY, an investor can gain exposure to the performance of the entire US stock market, which can help to diversify their portfolio and potentially reduce the impact of market volatility.
ETFs have grown exponentially since 1993 when State Street Global Advisors launched the SPDR® S&P 500 ETF Trust (SPY), the first US-listed ETF. Today, investors use ETFs to precisely meet their individual portfolio needs, from finding income and gaining broad market exposure, to lowering costs and investing in difficult-to-reach markets.