What is an ETF?
Overview of ETFs
Exchange Traded Funds (ETFs) began trading in 1993. There are now over 5,000 ETFs available around the world with $3 trillion in assets under management.
Briefly, an ETF is a basket of securities that you can buy or sell through a brokerage firm on a stock exchange. ETFs are offered on a variety of asset classes from traditional investments to alternative assets like commodities or currencies. In addition, innovative ETF structures allow investors to short markets, gain leverage and avoid short-term capital gains taxes.
In general, ETFs are similar to mutual funds, however one big distinction remains: Exchange Traded Funds can be traded throughout the day as often as desired, whereas traditional mutual funds can only be bought at the close of the NYSE (3 p.m. Central Time). ETFs are appealing to small and large investors alike.
With the wide variety of ETFs, one can structure an asset allocation strategy that would include stocks (large-, medium- and small-cap stocks), bonds (Treasury bonds, Corporate bonds, junk bonds in a variety of maturities) and alternatives such as commodities and managed futures.
Factoid: The ETF industry has grown to a $3 trillion industry over the past 24 years. iShares (Blackrock), SPDR and Vanguard are the three largest ETF sponsors.
The Top ETFs ranked in terms of Assets Under Management
| Ticker | ETF | Assets Under Management | Average Daily Volume |
| SPY | SPDR S&P 500 ETF | $239,276,052.61 | 76,066,969 |
| IVV | iShares Core S&P 500 ETF | $116,403,069.01 | 3,442,363 |
| VTI | Vanguard Total Stock Market ETF | $80,155,071.96 | 2,225,017 |
| EFA | iShares MSCI EAFE ETF | $76,534,431.32 | 20,503,482 |
| VOO | Vanguard S&P 500 ETF | $69,859,178.73 | 1,969,200 |
| VWO | Vanguard FTSE Emerging Markets ETF | $55,316,826.32 | 12,083,938 |
| VEA | Vanguard FTSE Developed Markets ETF | $54,325,375.85 | 8,310,451 |
| QQQ | PowerShares QQQ ETF | $52,285,624.98 | 25,010,881 |
| AGG | iShares Core U.S. Aggregate Bond ETF | $45,720,552.20 | 2,177,791 |
| IJH | iShares Core S&P Mid-Cap ETF | $40,612,471.42 | 1,474,611 |
| IWM | iShares Russell 2000 ETF | $37,799,641.52 | 30,030,736 |
| IWD | iShares Russell 1000 Value ETF | $37,331,007.20 | 2,208,491 |
| IWF | iShares Russell 1000 Growth ETF | $36,220,280.68 | 1,526,929 |
| GLD | SPDR Gold Shares ETF | $35,484,409.60 | 7,823,456 |
Pros and Cons of ETFs
Pros
- ETFs combine the range of a diversified portfolio with the simplicity of trading a single stock. Investors can purchase ETF shares on margin, short sell shares or hold for the long term.
- Given that ETFs track an index such as the S&P 500 or Nasdaq and are passive investments, annual management fees are usually very low, some of which charge less than 0.10% per annum. In addition, there are no sales charges or loads as with your typical mutual fund.
- ETFs are bought and sold just like common stocks through a brokerage account. If you have traded stocks through a discount or full service broker, you are all set for transacting in ETFs. You will pay a commission to buy and sell ETFs just like stocks
- Tax efficiency. Because of the way passive (i.e. indexed portfolios) are managed, capital gains taxes are minimized. However, short term gains from trading ETFs actively, are not as tax efficient as other vehicles such as futures contracts.
Cons
- For an active trader, the commissions will add up if you buy and sell ETFs many times throughout the day.
- While some ETFs have very narrow bid/offer spreads, there are many ETFs that have wide bid/offer spreads and very little liquidity.
- Tracking error. Some ETFs track their underlying indexes very closely. But some display tracking error. For example, the ETF may advance 9% over the course of a year, yet its underlying index may have advanced 10.10%.
- ETFs do not trade 24 hours a day like futures contracts do.