The Exchange-Traded Funds, like traditional funds, have a basket of securities (stocks or bonds) or swaps or any type of contract that provides the same return as a particular basket of stocks (like for example an ETF based on the Dow Jones Industrial Average#1). The main difference between an ETF and a background of traditional investment is how investors buy and sell shares. While in a traditional fund investors buy its shares to a management company and resell them when they want to cash it back, in an ETF investors buy and sell their shares on a stock exchange, just as they would if they wanted to buy or sell shares of a company. For this reason, investors should use a broker if they wish to buy or sell shares of ETFs.
As the name suggests, ETFs traded on a market (Like the New York Stock Exchange) throughout the day just like any action. By contrast, the price of traditional investment funds established once daily and investors should process their orders before a certain cut-off time of the price of that day. Also, unlike funds, one can operate with ETFs in the same way as you do with actions, like placing limit orders, go short or lend them.
ETF providers have focused increasingly on providing products for investors who wish to invest in a specific market segment. The universe of ETFs is packed with funds that focus on a single sector, industry or geographic region. Let’s say you like indexing and want to invest in a specific market niche, such as chemical companies. There may not be many index funds that follow this industry, but ETFs do. In addition, many more ETFs than funds invest in a single country. The ETFs offer investors a way to invest in a market segment without having to bet on one or two individual values (besides, it is more profitable in terms of brokerage costs)
However, it must be said that funds overly focused on a segment of the market through funds or ETFs may also be too aggressive for many investors. That is because investors tend to buy and sell these products at the most inopportune moments, when things are going well.
That does not mean that funds focused on a particular niche cannot be used intelligently. For example, ETFs can be used to invest in undervalued through a single title sector. If you invest in ETFs niches may make sense to be something “counteract” and not run after those who are too hot. You can find investment opportunities in market areas that have suffered greatly in the last three or five years using some statistical work. As economy is based in cycles and at some point what has been lost will be recovered.
Costs related to an ETF
ETFs do not have to manage hundreds of customer accounts and call centers, so have lower administrative costs, which means lower total expense ratios. But still must pay broker commissions when buying and selling stocks and the costs of operating so quickly or even occasionally can make it even more than offset for the initial advantage of a lower expense ratio of the ETF. For these reasons, ETFs are the most efficient in terms of costs to those who pay commissions for brokerage. Suddenly investing a lot of money and maintaining the investment for a long time can be a good strategy to buy an ETF if the market has been recently penalized and looks like will recover soon. For others, an ETF may not be such a cost advantage compared to traditional index fund.
Special Situations that need the use of a ETF
ETFs are also an interesting option for some market areas which are not offered by traditional funds, or are few or expensive or managed by managers with little experience. It is important to analyze the type of benchmark that has that ETF and if the commission that charges is suitable with our needs in our portfolio.