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What Is an Exchange-Traded Fund?
Exchange-traded funds (ETFs) are just one of the many types
of investment funds available, but they have some qualities that are unique
and set them apart from other vehicles. ETFs are securities that attempt to
track all types of indexes, industries, or commodities. For example, an ETF
might be made up of securities representative of the technological industry
or of the S&P 500. The most famous exchange-traded fund is the Standard &
Poor’s Deposit Receipt, or SPDR, which follows the S&P 500.
When ETFs were first created in the 1990s, the aim was to
mimic the movements of an index of a specific financial benchmark. Today,
ETFs also follow industries and commodities, not just indexes. The
investment vehicle with the sole purpose of mirroring a specific index is
called an index fund.
One of the reasons some investors may choose ETF funds is
because they combine the diversification of a mutual fund with the
flexibility of a stock. ETFs do not have their net asset values calculated
each day, as do typical mutual funds, but rather their prices may fluctuate
throughout the day based on the rate of demand on the open market.
Although the value of an ETF comes from the worth of the
underlying assets comprising it, shares may trade at a “premium” or a
“discount.” ETF shares are sold on stock exchanges; investors can buy or
sell them at any time during the day. The underlying assets of the fund are
not affected by market trading.
Exchange-traded funds may have expense ratios that are lower
than those of an average mutual fund, and they are usually more
tax-efficient than most mutual funds. Additionally, shareholders can often
invest as little or as much as they desire. However, an ETF cannot be
redeemed by a shareholder; rather, it can be sold only on the stock market.
A downside to exchange-traded funds is the commission fee,
which is generally not associated with a mutual fund. Commissions are
involved because ETFs are traded like stocks, rather than like mutual funds.
However, despite this downside, an ETF can be a diversified and low-cost
investment that often has a low turnover rate, so you might want to consider
ETFs as part of your investment portfolio.
The value of ETF and mutual fund shares fluctuates with
market conditions. Shares, when redeemed, may be worth more or less than
their original cost.
Mutual funds are sold only by prospectus. Please consider
the investment objectives, risks, charges, and expenses carefully before
investing. The prospectus, which contains this and other information about
the investment company, can be obtained from your financial professional. Be
sure to read the prospectus carefully before deciding whether to invest.
© 2007 Emerald Publications
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