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The ABCs of ETFs: An Introduction

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We Women Around Town must be financially astute, whether or not we have husbands or significant others helping to call the shots. This column is the first in a three-part series on prudent financial management and focuses on investments in Exchange Traded Funds, commonly referred to as ETFs. Of course, everyone’s financial situation is different and before investing in any ETF, it is important that you consult your tax and investment advisor to see if these investments are right for you.

A convenient way to build and manage an investment portfolio is through the use of ETFs. In basic terms, ETFs are an index of underlying stocks, and they are “benchmarked” to the underlying index. For example, Ishares (now owned by Barclays) offers IYY, an ETF that is a broad market index based on the Dow Jones Industrial Average of 30 stocks.

ETFs are similar to mutual funds, with some important differences. First, ETFs follow a particular index of stocks and bonds (in the above example, the Dow Jones Industrial Average). Second, the fees for ETFs tend to be lower than for mutual funds. Third, while mutual funds may require minimum investments of certain dollar amounts, ETFs may be purchased in virtually any increment. Finally, ETFs are very tax efficient, since you control the buying and selling process, as opposed to the fund manager. Mutual fund managers take capital gains throughout the year, and you, the shareholder, must recognize your proportionate share, which can play havoc with year-end tax planning. ETFs put you in control of your yearly tax planning.

With this as a backdrop, the ETF arena is exploding. There are funds focused on regions, countries, sectors and industries, with combinations of all. There are bond funds across global financial systems, various currency funds, and funds devoted to alternative investments e.g., hedge funds, private equity and real estate. With all of these permutations, it’s sort of like Priceline.com: you almost can name your own ETF.

And, there are nearly as many providers: Powershares, Ishares, S&P, and even a relatively new group, Emerging Global Shares that focuses on, you guessed it, emerging global markets.

Conveniently, you can check your EFT’s holdings anytime, as virtually all funds post this information online. For example, if you go to Ishares.com and click on US Market Cap Style on the left side of the screen, and then select Broad Market from the pop-up menu, and then Dow Jones US Index Fund (IYY), you can see that index’s holdings. The same is true for any ETF – simply go to the issuer’s website, click on the symbol, and the underlying companies or bonds are listed. Even better, they are updated every 15 seconds, although it may take longer than that to hit the website.

Building a portfolio with ETFs is simple from an execution standpoint, and it makes monitoring fairly simple, too. Most money managers agree that in today’s global economy, a portfolio needs representation across global asset classes, and ETFs are an efficient way to get that global representation. In Part 2 of our discussion of ETFs, we will discuss various asset classes and how to structure a portfolio. Of course, you must consult your accountant, investment and tax advisors to determine if ETFs are appropriate for you.  Read Part 2 and Part 3 of this series here.

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