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Monday, March 21, 2011

Benefits of investing in exchange traded funds

Exchange traded funds, also called ETF's, have an array of financial advantages not necessarily available through competing financial products and instruments. This article will discuss ETF's, their benefits and ability to advantage investors' financial objectives.

ETF's combine multiple asset investments such as company stocks and place them into one financial instrument called an ETF which is managed by a fund specialist and overseen by an affiliated bank.  ETF's are similar to Mutual Funds in the sense they combine assets into a fund, but are also traded in secondary markets such as the stock exchange. This allows brokers and investors to purchase and sell shares of the fund freely.


Historical performance of exchange traded funds (ETFs)


Since the inception of Exchange Traded Funds in 1993 (online.wsj.com), ETF's have gained ground in the investment world in terms of volume and awareness. The amount of funds invested in Exchange Traded Funds has increased dramatically along with investor interest in these financial instruments.

The capital appreciation and value of ETF's underlying assets varies on market conditions, investor confidence, quality of the ETF's investments etc. making the historical performance of ETF's in general less accurate an indicator than each individual ETF. Some examples of Exchange Traded Funds are listed below.

• PXR: Invests in U.S. and International utility companies via Depository Receipts
• SPY: Large S&P 500 Index tracker with low expense ratio
• QQQQ: PowerShares Exchange Traded Fund: Well known Nasdaq 100 tracker fund
• EWJ: Ishares International Japan: Invests in Japanese company stocks


Benefits of exchange traded funds (ETFs)


The benefits of Exchange Traded Funds (ETF's) address the concerns of investors which typically center around wealth management and financial planning. Consequently, the ability of ETF's to meet investor and financial institution's financial planning goals is an essential ingredient in their composition and structure. There are several advantages to using Exchange Traded Funds, several of which are listed below.

• Lower risk: Pooled investments tend to average out risk
• Diversified investments: ETF's spread investments across multiple financial products.
• Professional management: Fund management by experienced industry professionals
• Nontaxable earnings in some cases: i.e. ETF's that invest in non-taxable bonds
• Access to individually unattainable investments: Treasury notes and bills.
• Exchange in secondary markets: ETF's are a liquid asset class and easily transferred
• Lower Expense ratios: In some cases ETF management is cheaper than Mutual Fund's
• Index tracking: Some ETF's mimic the performance of financial indexes
• Federal regulation and oversight: Both the Securities and Exchange Commission and the Depository Trust Clearing Corporation review and monitor ETF activity. (seekingalpha.com)


How Exchange Traded Funds meet investment objectives


In understanding the benefits of Exchange Traded Funds, one may wish to realize how ETF's address key investor goals. These goals are what bring investors and funds together, and if funds were unable to help accomplish the financial objectives of their clients, obtaining funding for the ETF could be challenged.

In other words, the performance of the fund is in many cases, correlated to the Price to earnings ratio (PE ratio) of the fund. The higher the perceived future earnings of the fund, the higher the PE ratio will be indicating investor belief in the funds financial viability and performance. Some of the investor and institutional goals sought in ETF's are the following:

• Capital appreciation
• Diversification
• Risk management
• Income generation
• Tax and Estate planning products
• Retirement funding products

To summarize, Exchange Traded Funds are a financial instruments that reinvest large amounts of money across multiple companies and/or additional financial vehicles. ETF's may be used to mimic a batch of companies within an 'index' such as the S&P 500 or help its investors achieve specific financial objectives.

There are several advantages to ETF's that make them a useful tool within a financial portfolio and/or investment strategy. This article has discussed some of those benefits, the reasons for them and how they are accomplished through the Exchange Traded Fund.

Sources:

1. http://www.investopedia.com/terms/e/etf.asp
2. http://finance.yahoo.com/etf
3. http://online.wsj.com/ad/focusonetfs/history.html
4. http://seekingalpha.com/article/48402-are-etfs-safe-or-insured
5. http://www.etftrends.com