Learning The ABC's of ETF's
By Anthony Rhodes
When one stops to think about the notion of hybrid automobiles (combining the power of electricity with the reliance of combustion), there is a prescience that emerges in the mind, which points to this uniquely human ability to not only understand the world around us, but to manipulate its properties to the point where we can amalgamate the benefits of two separate items into something novel. And although the formation of this new entity doesn’t replace the items from which those properties were borrowed, it does allow the corresponding technology to advance; which ultimately paves the way towards further uses, which would not have existed, were such items not merged in the first place.
This coalescence is not limited to the automotive industry, but also extends to the world of investments. A tool now exists which combines the diversity of mutual funds with the tradability of stocks! They’re called ETF’s or Exchange Traded Funds. This week, we’ll take a look at these powerful instruments in an attempt to better understand their uses. But our ultimate goal is to answer the question: Can these hybrids of the investment community rev up the performance of your portfolio?
The primary reason why mutual funds are so popular is that they combine a basket of stocks (or bonds) into a single security. This grouping benefits the investor by balancing the everyday ups and downs of the entire portfolio against the everyday ups and downs of a single stock (or bond). An ETF offers a similar benefit. Exchange Traded Funds are comprised of securities within a specific index (think the Dow Jones Industrial Average or the S&P 500). They’re designed that way so that an investor can participate in a particular segment of the economy (think Biotech or Cloud Computing) in group form, rather than individually.
Conversely, stocks are beneficial simply because of their individuality. An investor purchases stocks because he or she seeks to participate in the single growth potential of one company. The price of the stock fluctuates based on how much someone is willing to buy or sell that single issue; which takes place throughout the entire trading day. ETF’s also work in this fashion. Instead of computing the Net Asset Value of all the stocks within a basket at the end of the day to determine the price of the security (which mutual funds do), an ETF can be purchased at any time throughout the day (like stocks are). This gives the investor the dual advantage of both instruments, but without the disadvantages of either.
Whether your preference is mutual funds or stocks, it might be a good idea to take a look at ETF’s as well. These clever, yet powerful instruments provide an investor with an ability not seen within our investment toolbox before; one which combines the intrinsic benefits of both securities.
(Anthony Rhodes is a Registered Investment Advisor and owner of wealth management firm The Planning Perspective www.theplanningperspective.com)