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Since being introduced in the mid
‘90’s, Exchange-Traded Funds have continued to grow in popularity.
Over 60% of money flowing into index fund-type vehicles is going
into Exchange-Traded Funds. Should you be using them? Read on to
find out.
I recently spoke in New York City at a national summit for financial
advisors that focused on Exchange-Traded Funds. Over 200 advisors
from all over the country attended and learned why the use of
exchange-traded funds can give them a competitive advantage and
benefit their clients. Whether you are a traditional buy and hold
investor, or actively trade to profit from shorter-term
opportunities, you should strongly consider their use.
Exchange-Traded Funds (ETFs) are designed to mirror a market index.
The three most popular stock market indices are the Dow Jones
Industrial Average, the S&P 500 and the NASDAQ. The ETFs that mirror
these indices are referred to as Diamonds, Spiders and Cubes because
their symbols are DIA, SPY and QQQ.
Exchange-Traded Funds provide the diversification benefits of a
mutual fund with the advantage of being traded like an individual
stock. Whereas a mutual fund can only be bought or sold based on
that day’s closing price, Exchange-Traded Funds can be bought or
sold anytime throughout the trading day. This allows you to more
quickly enter or exit the market during the day.
With over 172 different ETFs, there is an ETF for practically every
index available. In fact, ETFs track nearly twice as many
broad-based market indexes as traditional index mutual funds. This
creates amazing flexibility in structuring an overall portfolio to
the specific needs of any investor.
Besides many broad-based ETFs, there are also ones targeting
specific sectors of the market. And Exchange-Traded Funds aren’t
just for stock-based investments. There are separate ETFs that
invest in bonds, real estate, precious metals and other commodities.
There are ETFs designed for growth and others designed for income.
The internal expenses of most Exchange-Traded Funds are very low.
The average actively-managed mutual fund may have internal expenses
over 1% per year. The internal expenses of Diamonds, Spiders and
Cubes are less than 1/5 of 1% per year. (Since ETFs are purchased
like a stock, there is a commission to buy and sell them. The use of
a discount broker should minimize this expense.)
The majority of exchange-traded funds are not actively managed. In
that sense they are very similar to an indexed mutual fund.
Recently, though, actively-managed ETFs have been introduced to the
market. Expect more and more of these to become available over the
next few years.
Exchange-traded funds allow an investor to control when the taxes
will be paid on an investment, whereas in a traditional mutual fund
those decisions are made by someone else. An investor can also sell
a stock or mutual fund to generate a tax-deductible loss and then
replace that investment with a similar ETF.
Moreover, ETFs can be sold-short without having to wait for an ‘uptick’.
To short an individual stock you must wait for it to trade higher
than its previous trade (referred to as an uptick). As a result, it
can be difficult to sell-short when the market is falling. With ETFs,
you can easily sell-short in a falling market and thus profit from
it. This is one technique that can be effectively used to protect
the rest of your non- IRA portfolio.
To summarize, ETFs can be used in many ways. They can be used to
round out a portfolio. If you have several individual stocks that
you don’t want to sell for tax reasons, ETFs can be used to add
diversification. ETFs can be sold short so they can also be used to
protect the rest of your portfolio in a falling market. Or ETFs can
be used to increase specific exposure of an overall portfolio. For
instance, you could have international exposure but overweight Japan
by buying a broad-based international ETF and a Japan-focused ETF.
I use ETFs extensively in my client’s accounts because of their
flexibility and low cost. Your portfolio can probably benefit from
their use as well. If you would like to learn more about how to use
ETFs in your portfolio just let me know.
For clear, straightforward, unbiased answers to your financial
questions contact me at jeff@guardingyourwealth.com.
Mr. Voudrie is a Certified Financial Planner, nationally syndicated
newspaper columnist and President of Legacy Planning Group, Inc., a
Private Wealth Management Firm in Johnson City, TN. He can be
reached toll-free at 1-877-827-1463 or www.guardingyourwealth.com.
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