Business Commentary

What is an Exchange Traded Fund or ETF?

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I’d like to take this opportunity to talk a little bit about ETF’s, short for Exchange traded Fund. The ETF is an investment very much in the same way that stocks are. An Exchange Traded Fund is made up of stocks or other underlying assets that represent some common aspect of a specific industry. An example of this might be the oil services industry which would be made up of a basket of stocks that characterize the oil services industry (OSX). By purchasing an ETF, you basically are purchasing a “basket” or more correctly a specific weighted average number of stock shares for each company making up that fund. This makes investing in that industry much simpler than having to go out and buy stocks in each individual company.

A big difference between an ETF and a mutual fund is that Mutual funds trade at the price at the close of that trading day, so the price you see at the middle of the trading day may not be the price you pay or received at the close. An ETF trades much in the same way as a stock in this sense, as it is traded like a stock; at that price at that time you buy or sell, during any open market hours. Because the ETF is traded like a stock, investors can basically engage in any of the types of trades that can be done with most stocks, which is they can go long, sell short, or any types of stop or limit orders. Many ETF’s also have option availability, giving investors even more ability to enter into strategic investments and leverage their capital. Mutual Funds do not have these capabilities, making the ETF an attractive alternative for the savvy investor.

In addition to the buying and selling flexibility of an Exchange Traded Fund, another attractive element is the lower cost than that of other similar investment products. ETF’s generally have lower costs and expenses and are not actively managed compared to mutual funds. ETF’s also provide for increased diversification across a complete index.

Simply put, ETF’s allow for uncomplicated diversification while enjoying low expense ratios compared to purchasing the shares that would make up a basket of stocks that are the basis of a specific fund or index. Remember that you would be purchasing shares of many different companies to perhaps mimic an index. This would also mean paying commission on each purchase.

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