Investing in Exchange-Trade-Funds (ETFs)

Twenty-one years ago, January 29, 1993, the world’s first exchange-traded-fund, SPDR S&P 500 (SPY), was launched. Unlike traditional mutual funds that only price once a day when the market closes at 4 p.m., ETFs price continuously throughout the day, trading exactly like individual stocks. When you buy or sell a traditional open-end fund you never know the exact price you will receive because you must place the order prior to the market close to get that day’s 4 p.m. price. If you buy or sell after 4 p.m. it will be at the next day’s price.

ETFs

Typically ETFs are based on an index so that the basket of stocks (or bonds) bought or sold each day needs no manager as most traditional funds do (newer ETFs now offer managed funds). The trades are computerized, according to a pre-set formula (index), meaning that fund expense ratios – the amount subtracted each day to pay the sponsoring fund company – are extremely low. The first ETF fund, SPDR S&P 500 (SPY), is now the biggest ETF with assets totaling $181 billion, about 8% of the over $2 trillion invested in ETFs. SPY’s expense ratio is only .09% meaning that 99.9% of your investment will make (or lose) money. Compare its miniscule ETF expense ratio to the typical traditional-managed U.S. mutual fund that averages about 1%, 10 times higher than SPY.

Another big advantage of ETFs is their tax-efficiency. Because most ETFs are based on an index and because the sponsoring fund company can often exchange its own shares of individual stocks with its ETFs’ shares, annual capital gains are either non-existent or minimal. Given easy trading, low-cost, tax efficiency and incredible diversity, ETFs can be a wise portfolio addition for most investors.