While many investors have an overall outlook, and may be able to accurately predict what will be the next big thing, it is often harder to nail which company will be able to best take advantage of the coming conditions. After all, while it may be easy to figure out, retail stocks are going to be hammered by this recession, that doesn't help you decide which retail company is best to short. And while it may be easy to figure out, reduced demand from the developed world is going to hurt Chinese companies, its much harder " especially for those non-mandarin speaking people such as myself " to figure out exactly which Chinese companies might escape this fate. So how can we take advantage of these outlooks without having to pick specific companies? The answer lies in a little tool known as the ETF. ETF stands for Exchange Traded fund. Think of it as a mutual fund that isn't actively managed, focuses on a certain area, and can be traded like a stock without incurring extra penalties. Each ETF holds a number of companies, similar to a mutual fund, and its listed price is simply the overall value of the companies it holds. The purpose of an ETF is to allow an investor to purchase a single equity that represents an investment in a sector. So if an investor is interested in buying financial stocks, they could buy XLF. If they want some small cap goodies, they can choose to buy IWM. For some exposure to the Chinese stock market, they could invest in FXI. Finally, if they simply want to emulate the returns of the S&P 500 index, the SPY has them covered. But why shun the mutual fund? Why take the new guy over the established king? Lets start with the tax advantage. When mutual funds endure large sell offs, they have to liquidate many positions, some of which are currently at a gain. They then have to pay capital gains on those positions, and this negatively impacts their return. It would be an understatement to say that Mutual funds generally have higher expense ratios in general compared to ETFs. It can sometimes cost as little as 8 dollars to get into an ETF whereas a mutual fund of 20,000 that grows to 60,000 over a 20 year period may have conservatively lost as much as 18,000 to its competent managers. Of course, the vast convenience ETFs have over mutual funds shouldn't be underestimated. ETFs can be traded just like a stock, giving active traders the ability to buy and sell intraday. The ability to short was impossible with a mutual fund, but now it can be done. During any bear market, the ability to benefit from the fall of sectors as well as their rise is a valuable one to have. Furthermore, ETFs are often optionable, so risk can be minimized with covered calls and protective puts, or " if your so inclined " much larger returns can be sought through buying calls and puts on the ETF. Experienced stock option experts may even use advanced stock option strategies, like iron condors and vertical spreads to increase investment returns. One thing to note is that not all ETFs are created equal. While some simply hold a basket of stocks and use those to keep the ETFs value near the benchmark, many use other, more exotic strategies, with various degrees of success. QLD for instance, aims to gain roughly twice the daily returns of the Nasdaq composite index, and is usually fairly consistent when doing this. Another similar instrument is the ETN, which is actually a debt based instrument. While ETNs also aims to gain returns based on a given benchmark, there price is also sensitive to changes in the debt rating of the issuer, and this should be considered when investing in them. ETFs are a diverse tool that allows one to remove risk from ones portfolio by investing in sectors instead of individual companies. They allow investors to benefit from downturns in markets as well as the uptrends. And they allow the investor to take advantage of options on sectors, which options-savvy investors can use to supercharge returns. Given their great variety of uses, ETFs should be a valued part of any investors portfolio, to be ignored at the investors peril.
Please Rate this Article 5 out of 54 out of 53 out of 52 out of 51 out of 5
Not yet Rated
