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?
Mutual Interests
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.
Stock Mock
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 the President and owner of wealth management firm The
Planning Perspective www.theplanningperspective.com. Do not reproduce without permission.)
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