ETFs

Overview

Exchange traded funds, or ETFs, are mutual funds that you can purchase as investments just like you can purchase stocks. You can purchase these investments through your stock broker as you would buy ordinary stocks. ETFs hold assets like stocks or bonds and trade at almost the same price as the net asset value. Only authorized participants can buy or sell shares of an ETF directly to or from the fund manager.

How It Works

Because exchange traded funds are mutual funds, each fund can hold any number of companies. A fund can comprise a dozen companies or even a thousand companies. All the companies in a fund will have something in common. For instance, all the companies might serve the healthcare industry or all of them might fall under the umbrella of technology.

Exchange traded funds are sold in blocks, instead of shares. One block might contain hundreds, thousands, or more often hundreds of thousands of shares of the companies in that fund. That large block of shares is known as a creation unit in ETF circles. Unlike traditional mutual funds where shares are created when a fund becomes successful, ETFs are created from existing shares that are grouped together to track an index. Index refers to the group of companies that make up the fund.

Since ETFs are traded like stocks, they can be bought and sold all day. And an investor can even bet against an index with an ETF and makes a profit or loss depending on the performance of the index.

Benefits

ETFs generally have lower overall expenses because they are based on the rise and fall of an index and are not actively managed like traditional mutual funds, where the managers must decide when and where to invest funds. ETFs allow you to make money in any market.

Exchange traded funds are also a good option for investors who have a limited amount of money to get started in the stock market. You can start with the purchase of one share through your broker. If you use a discount broker with a low minimum balance and cheap trades that are $10 or less, you can minimize the brokerage fee, which is the biggest expense in exchange traded funds.

Cost/Pricing

The cost depends on the ETF you want to purchase and how many shares you buy. With a discount brokerage account, which you can get for a small amount of money, it's easy and inexpensive to buy and trade shares of exchange traded funds. The cost can sometimes be as little as a few dollars per trade.

Timing

You can buy the ETFs when the price is low and sell them when the prices rise. To do this you must constantly study the market and must be able to predict the changes in the market.

Companies/Industries

You can trade ETFs through any stock broker, including local brokers or online discount brokers like E-trade, Ameritrade, Scottrade, Sharebuilder and other online brokerage companies.