Benefits of trading ETFs

TradingPub Admin | March 14, 2013

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If you are looking to learn more about exchange-traded funds (ETFs), which have been generated significant visibility and robust inflows since being created in 1993, here are some quick pointers that can help.

ETF basics
An ETF is a stock certificate that provides the purchaser with exposure to an underlying bundle of assets. For example, the first fund of this type ever created was the Standard & Poor's Depositary Receipt.

This ETF was created by State Street Global Advisors and offers buyers exposure to the individual stocks contained in the S&P 500 Index, according to Yahoo Finance. By purchasing a share of this ETF, which trades under the ticker symbol SPY, you can quickly invest in this group of blue-chip equities.

Trading characteristics
These financial instruments differ from mutual funds in that they are traded like stocks. Whereas mutual funds are priced once during a trading session, ETFs are traded continuously. These financial instruments can be traded intraday, or in other words in the middle of a regular session.

This can prove advantageous, as you can profit from short swings in assets that happen in the same day. For example, let's say you think that the blue-chip S&P 500 will surge today due to the release of news that will make markets more bullish. You can buy an ETF to easily obtain exposure to this group of stocks early in the session, and then sell the financial instrument later in trading.

In addition, you have the ability to both short sell these financial instruments, and take long positions on them. These represent more advanced trading strategies you can use to speculate on the future value of the asset markets.

Low expenses
One factor that has drawn many investors to ETFs is their low expenses, ETF Trends reports. Unlike mutual funds, which pay a team of individuals to actively buy and sell assets, most of these securities passively track indices - for example the S&P 500. Since they do not require a management team, they come along with lower costs.

InvestorGuide reports that another benefit of the financial instruments is that before you actually acquire any shares of the ETF, all commissions, management and operating fees will be deducted first. The same process exists for mutual funds, but since these financial instruments are actively managed, anyone buying them ends up with fewer shares than they would if they alternatively put the same amount into ETFs.

At the end of the day, the financial instruments carry an average expense ratio between 0.1 percent an 0.7 percent per year.

Tax efficiency
Another major draw of ETFs is the tax efficiency that they offer. Mutual funds make frequent trades, which generate short-term capital gains. These come along with higher tax rates than long-term capital gains, according to ETF Trends.

Those investors who hold substantial amounts of these funds have the ability to obtain in-kind redemptions, which means that they have the ability to exchange their ETFs for the underlying equities they represent.

If you are looking to construct a portfolio and invest over the long term, it is important for you to obtain diversification. What this idea means is not putting all of your eggs in one basket. InvestorGuide notes that if you are looking to invest using a longer period, you may want to change the general riskiness of your portfolio, and you can do this far more easily by using ETFs to rapidly change your asset allocation.

If you want more information on the asset markets such as stock trading education, you can find it available through TradingPub, home to some of the top investors and traders in the industry.