Exchange Traded Fund Basics

Over the last 30 years, exchange traded funds have become a popular and inexpensive way for investors to achieve their asset allocation goals. ETFs have many advantages, but also some complexities. Today we are going to discuss ETFs and the role they can play in an investment portfolio.
The first Exchange Traded Fund, the S&P 500 Depository Receipt (SPDR, pronounced “Spider”), was launched in January of 1993. From those humble beginnings, the ETF industry has grown to over 17,000 funds with over $22 trillion in assets. (Source: JP Morgan)
ETFs offer several advantages over other investment vehicles. Like mutual funds, they offer easy diversification, especially for investors with smaller portfolios. ETFs are often designed to mimic an index, and as such, proportionally invest in all the securities that the index invests in, often numbering in the hundreds or thousands.
They can also be used to gain exposure to particular areas of the market, such as sectors or geographic regions. Exchange Traded Funds are usually fully invested, without any significant cash position, and may be less prone to drifting from their investment objective than traditional funds.
Because ETFs are exchange traded, they offer flexibility not found in traditional mutual funds. ETFs can be traded throughout the day, rather than purchased or redeemed at the end of the day. This gives investors the ability to take advantage of intraday price movements. In addition, ETF shares can be purchased on margin, can be sold short and give investors the option of using stop-loss and limit orders.
Because many ETFs are passively managed, they tend to have lower expenses than traditional mutual funds.
Actively managed mutual funds employ managers, and often large teams of analysts and traders, to make investment decisions. ETFs seldom make changes to the portfolio, especially if they are designed to track an index. ETFs are purchased like a stock, either for a commission, or as part of fee-based strategy, eliminating the share classes and load types associated with traditional mutual funds.
Lower expenses aren’t the only benefit to less frequent trading. Lower portfolio turnover also means fewer realized capital gains. This tax-efficiency may help to give you more control over your tax bill. Of course, when you sell shares of an ETF, you may incur a capital gain or loss.
Exchange Traded Funds can help you construct your portfolio by giving you broad, diversified exposure to market segments, and can be great components in an asset allocation program.
You can also use ETFs to help balance your portfolio among market sectors. For example, if you need exposure to healthcare or to emerging markets, there are ETFs that will give you that specific exposure.
ETFs are not perfect, but they do have some key benefits that can help to build the portfolio you want.
Important Disclosure:
Michael Bergen is a Partner, Managing Director at Beacon Pointe Advisors LLC. The information contained in this article is for general informational purposes only. Opinions referenced are as of the publication date and may be modified due to changes in the market or economic conditions and may not necessarily come to pass. Past performance is not a guarantee of future results. Beacon Pointe has exercised all reasonable professional care in preparing this information. The information has been obtained from sources we believe to be reliable; however, Beacon Pointe has not independently verified or attested to the accuracy or authenticity of the information. The discussions, outlook and viewpoints featured are not intended to be investment advice and do not consider specific investment objectives or risk tolerance you may have. All investments involve risks, including the loss of principal. Consult your financial professional for guidance specific to your circumstances.