Doh! is what you’re probably thinking if you’ve been invested in a mutual fund lately. Why? Because you could have saved yourself the fee’s that the mutual fund has been charging you (which is chipping away at your returns), by investing in an ETF instead.
Whether you’re Day Trading, Swing Trading, Position Trading, or Investing for the long run, ETF’s are a great way to save on fees and have a wide array of opportunities.
What Is An ETF?
ETF stands for Exchange Traded Fund. In the same way that Mutual Funds and Hedge Funds are asset management firms that manage their respective funds, Exchange Traded Funds are funds that are publicly traded.
A Hedge Fund and Mutual Fund are limited to a particular group of investors. Anyone with a brokerage account can invest in an ETF by buying shares in the fund through the exchanges. ETF’s trade just like Stocks.
How Are ETF’s Different From Stocks?
ETF’s are similar to Stocks. However, when you buy shares in a Stock you are purchasing ownership in a particular company. How much your shares of Stock go up depends on the success or failure of the company you’re invested in.
An ETF is a fund, and the fund is invested in a group (also referred to as “basket”) of Stocks. For instance, SPY is the ticker symbol for the S&P 500 ETF. If you were to buy shares of SPY, you would be invested in a basket of Stocks that are managed by the ETF.
This is a huge advantage for the average investor, because it allows you to be well diversified across a group of the 500 largest Stocks in America, without having to own individual shares in each company.
There Are Multiple Types of ETF’s
As was just said, and ETF is a fund that invests in a basket of Stocks on your behalf. But it doesn’t have to be just Stocks. There are ETFs that invest in Bonds, Currencies, Gold, and other commodities.
Some of the most popular ETFs include:
- TLT – iShares 20-Year Bond ETF
- GLD – SPDR Gold Shares ETF
- SPY – SPDR S&P 500 Trust ETF
- IWM – iShares Russell 2000 ETF
- DIA – SPDR ETF that tracks the Dow Jones Index
- QQQ – PowerShares ETF that tracks the Nasdaq 100 Index
- XLF – Financial Select Sector SPDR Fund
- FXE – CurrencyShares Euro Trust tracks the Euro
Here’s an ETF search by ETFdb.com. You can find an ETF for just about anything.
ETF’s Have Very Liquid Options Markets
For those of you looking to be a little more active in the markets, there’s a wide variety of Options strategies you can use to take advantage of nearly every kind of market situation.
ETF’s tend to have very liquid Options markets, with is great for traders looking to take advantage of opportunities in a variety of markets, or hedge against their current positions.
Mutual Fund or ETF?
Most funds set out to at least match the returns of the S&P 500, which is about 6-8%. As we alluded to in the beginning, most Mutual Funds (actually all of them. These aren’t charities) charge a management fee. Typically, the management fee is about 1%.
By circumventing a Mutual Fund and investing in an ETF, you can avoid the bulk of these fees. However, keep in mind that the ETF will still charge you a fee. This fee is called an expense ratio, which is just a fancy way of saying “maintenance fee”.
Hey, the people who work at the ETF have got to eat too.
Moreover, most Mutual Funds will have a minimum investment amount, before you can invest in the fund. This amount can range depending on the fund. Also, most Mutual Funds have a lockup period on your money. In other words, more often than not you won’t have the ability to access your funds while they are in the lockup period.
This is another one of the great benefits to ETF’s. You get the good parts of a Mutual Fund, with easy access to your funds at any moment. Since ETF’s trade like Stocks on the exchanges, you can just sell your shares and cash in your money at any time.
Hedge Fund or ETF?
Hedge Funds were originally designed to be (as the name suggests) a hedge against adverse market movements and provide uncorrelated returns when compared to the broad market. However, their function has changed a little bit, with their main focus on producing Alpha.
Hedge Funds are similar to Mutual Funds, except they typically employ leverage to amplify returns. Hedge Funds often also short the market or individual Stocks/Currencies, which is uncommon in your typical Mutual Fund.
The issue with the average investor wanting to invest in a Hedge Fund is that most Hedge Funds are very exclusive. You also have to be an accredited investor, which means you need to have:
- An income of $200,000+ for the past 2 years (if you’re single)
- A joint income of $300,000+ for the past 2 years (for couples)
- (or) a minimum net worth of $1,000,000
As you can probably tell, this is out of reach for most people. Plus, even if you are an accredited investor, a Hedge Fund doesn’t have to take your money.
Hedge Fund or Mutual Fund?
Though Hedge Funds are similar to Mutual Funds (aside from leverage and shorting), Hedge Funds are far more competitive than their Mutual Fund counterparts.
A Hedge Fund’s performance is measured in absolute returns, rather than relative returns. What does this mean? It comes down to fees.
Many funds base their performance off of the S&P 500. If a Hedge Fund beats their benchmark return, they will charge a performance fee as an incentive for beating the broad market.
Typically this fee is 20% of the gains made, on top of their 2% management fee. This combination of fees is often referred to as “2 and 20” in the industry.
Where the concept of absolute returns comes into play is when the market has a down year. If the S&P 500 loses 35% in a year, a Mutual Fund that only lost 30% will still be thought of as beating the market.
A Mutual Fund will typically give the excuse that it was a rough year (which there’s no denying), but they will not be crucified like a Hedge Fund would be if they were in the same situation. A Hedge Fund that loses 30% when the broad market is down 35% in a year will most likely go out of business.
For most people, an ETF is the answer they’ve been looking for. ETF’s provide an array of opportunities for investors to make diversified investments in an array of assets and sectors. An ETF is a great way to save on your typical commissions that most Mutual Funds have.
They’re also a great trading vehicle for those that are looking to be more active in the markets. Most importantly, they give you absolute control on your portfolio.
With power comes responsibility, but at the very least you’ll know what’s going in your portfolio and won’t have to go through the middleman that is the Mutual Fund.