Exchange Traded Funds (ETF)

An exchange traded fund is meant to give the same return on investment as a correlating index without costing the investor so much. ETF’s are index-based investments that give a performance based on a correlating index. To understand ETF’s we must first understand indexes.

An index is a collection of stocks that represent an industry. The OSX, for example, is a collection of shares from several oil companies. This is a good investment because you generally want to diversify your portfolio. In other words you want to buy from several different companies rather then a few because you run less risk of losing money. Several companies are less likely to fail then a handful of companies. Don’t put all your eggs into one basket is the basic mindset behind diversification. The problem is that you will need to buy a few hundred shares in about fifteen different companies. That is very expensive and the commissions on all those buys adds up.

An exchange traded fund is a mini-portfolio of companies. It allows you to pay one fixed price rather then several different prices on varied stocks. With an ETF, however, you cannot move your stocks around because you haven’t invested in the companies themselves. You’ve invested in a portfolio. Your stocks are in the hands of several companies and you can’t focus on one that you think will do especially well.

For the investor with less cash that remains new to the stock game, ETF’s are of great use. They are flexible, give immediate dividends, and they are tax friendly. While indexes may give more ownership, they are also expensive and more risky. Investing in a number of companies is good diversification. It should be remembered, however, that ETF’s are not as good for long term investors, they trader lower and more infrequently, and their international use is limited by differing laws. 

Rather you invest in ETF’s, an index, or stock depends on your situation. The key is to know a great deal about all three and about the market. Educate yourself and don’t risk more then you can afford to lose. With time you’ll see what works best and you’ll end up making money off of your money. Savvy investors enjoy putting their money to work for them rather then working for their money. It’s a good feeling that too few people enjoy. There is plenty to gain and plenty to lose, but it’s a fun game to play.