What are Exchange Traded Funds

Exchange traded funds or the ETFs are the index tracking funds. They are listed on the stock exchange and can be traded like single equities. An ETF tracks the value of a stock index or the market as a whole. They are liquid funds and can be easily bought or sold exactly like a stock of an individual company throughout the trading day. ETFS provide a wide range of investment options. They can help investors build a diversified portfolio that’s easy to track.

Most ETFs represent a portfolio of stocks designed to track the performance of the market indexes. Since the indexes constantly drop poor performers and pick up the good ones, a trader is always investing in the best performers that the market has to offer. Therefore, your index tracking ETF delivers returns in accordance with the general market trends.

The advantages of ETFs over Mutual Funds

Investments in ETFs are considered better investment options than mutual funds. Even a good mutual fund may stop performing as well as the market over a period of time. There are several reasons for this:

1. There are hundreds of mutual funds in the financial market. An ordinary investor may find it difficult to analyze and compare the functioning of these funds. Moreover, every fund may not have competent fund manager.

2. Mutual funds generally have high fees and overhead charges. They cumulatively tell adversely upon the real performance of the fund. The returns fall dramatically over the time.

3. The portfolio manager of a mutual fund showing good performance may leave it for better chances elsewhere. The successor may not be as good as his predecessor.

4. Mutual funds are actively managed. A fund that delivers 30% in the first year may not perform well in the next year. The company may well tell you boldly how they delivered 30% in the previous year, but in reality will not reveal that their actual return was much less if you factor into the losses. Even the star performers in mutual funds may fall within a matter of two years. Remember the super performance of the dot.com stocks and the funds that heavily invested in them.

5. Mutual funds have the history of performing poorly over the long term except for brief periods where only 50% of them could beat the market.

In contrast to the mutual funds, the index tracking exchange traded funds perform like the market. It shows an overall gradual but positive uptrend. ETFs do not employ the high profile expensive managers like the portfolio managers in the mutual funds. They do not incur maintenance costs, fees for paper work or function from posh offices. An index tracking ETF is, in fact, only an instrument that tracks a market index like the NASDAQ 100 or the S&P 500. Of course, you cannot expect instant dream profits, but you do not have to suffer huge losses as well. The reason for this is that an ETF market rises historically. Moreover, you can buy an index trading ETF at the fraction of the cost of a mutual fund and yet expect a much higher return.

The pro and con arguments about ETFs versus Mutual funds boil down to whether you want a low probability of an amazing return, or a high probability of a good return. This can be explained by an example:

Suppose you invest $ 10,000 with a popular market-tracking index ETF with a historical return of 10%. Your total return over a decade should be $25,937. Let us say you invest the same amount in a mutual fund for the same period, Chances are that only one or two out of ten, or around 15% would beat the market index fund. This means that out of ten possible investment returns, only one or two would surpass the return offered by the exchange traded funds. The odds evidently are 5 to 1. There is also a possibility that your investment in a mutual fund may end up in losses. Even if you earn profits, they may be more than nullified by their heavy fees and overhead charges.