ETFs are Exchange Traded funds. Essentially ETFs are funds that are used to track a variety of indices. When you purchase shares in an ETF what you are really buying is a piece of a portfolio that is designed to track the yield of the native index. ETFs are different from index funds in that they are not designed to outperform their index but rather to replicate their own performance.
ETFs have been around since the beginning of the eighties but recently they have become more popular in the last decade or so. They have risen to popularity for a variety of reasons including the fact that they allow you to hold a diverse portfolio, to passively manage your assets, the flexibility of ETFs, and the efficiency of the ETF.
Because ETFs are tied to an index they are inherently diverse. Diversity is important when investing because it helps shield you from the risk of having just a single asset. As the saying goes “don’t put all your eggs in one basket”. ETFs also have most of the same features as general stocks in that you can buy them on margin, short sell them, or keep them for the long term.
ETFs also allow you to passively manage your goods. Oftentimes investors will spend a great deal of money on a fund manager that will make sure your money is being invested properly. Or they will invest their own time and energy into keeping an eye on the market. ETFs are tracked to an index and they stay tracked to the index so there is no need to pay for a fund manager and all it takes to invest in a particular ETF is a belief that a particular index is going to do well over the long haul.
ETFs are also highly cost efficient because there is little need to hire administrators. The typical administrative cost is less than .43% per year according to ETFD.com which is significantly lower than the typically 1% per year of a mutual fund. These management costs come straight out of your profits and thus they can have a real impact on the amount of money your fund is making. The efficiency of ETFs is one of the biggest reasons why ETFs have become really popular in the investing community.
Flexibility is important and investing and ETFs allow for a great deal of flexibility. They can be traded just like stocks and their price changes throughout the trading day. If you are used to the flexibility of stocks, then you will find ETFs to be quite similar.
ETFs are one of the most popular mechanisms for investing out there because they are efficient, allow for less administrative costs, allow for a diverse portfolio, and are flexible.