What are ETFs? Exchange Traded Funds Explained

ETFs or Exchange Traded Funds have been around since the 1980’s but with all the stock market volatility of the past 6 years or so ETFs have gathered more and more attention from serious investors. But what is an ETF and how can they benefit you as an individual investor?

What is an ETF?

ETFs are funds that are designed to track certain indexes within the market such as the Dow Jones, S&P 500 or the FTSE 100 for example. You can also buy ETFs that track the overall performance of certain commodities or precious metals like gold and silver. The basic idea of an ETF is to allow individual investors to enjoy the benefits of having a large diversified portfolio whilst taking away some of the hassle and risk associated with having to invest in lots of individual shares, some of which can behave in quite a volatile manner. This is not to say however that ETFs might not at times act in a highly volatile manner, after all it all depends on the behaviour of the particular index or asset class they are tracking. In general though, overall market indexes tend to behave in a less volatile manner than individual stocks as they are generally less affected by pieces of bad news that may come out about the performance of an individual company. I say in general because bad news about certain companies does have the ability to drag a whole market down as we saw with the collapse of Lehman Brothers during the credit crisis. It’s worth mentioning here that this lack of volatility may also not apply to an ETF that tracks commodities or precious metals, if the price of gold plummets for example then you can expect the value of your ETF holding to plummet with it. So if you’re looking for less risk then it’s probably wise to go for an ETF that tracks one of the less volatile indexes like the Dow Jones.

The Benefits of an ETF

ETFs are chosen by many investors because they incur less administrative charges than that of an actively managed fund. ETFs tend to invest in fewer stocks and also stick to those that are historically less volatile and better track the overall market, because of this far fewer trades need to be made and as a result ETFs incur less management fees.

Will an ETF outperform the market?

The general answer to this question is no but there are some ETFs out there that are known to take a little more risk in an attempt to do just that, outperform the market they track. Though this does seem like a contradiction in terms and many investors would question whether this approach is truly giving them the security they are looking for.

Do ETFs pay dividends?

Many ETFs do pay dividends and they are distributed evenly amongst shareholders and are typically deposited into your brokerage account. If you’d prefer not to receive dividends though, they can usually be reinvested or you can instead look for those that concentrate on growth stocks rather than those that pay dividends. Just keep in mind the brokerage fees will often apply if you want to reinvest your dividends.

Where can I invest in ETFs?

As with most investments these days online platforms such as iii now allow individual investors to easily invest in ETFs from the comfort of their own home and you can also find a wealth of information online to help you choose the right ETF for your needs and to compliment your investment strategy.

Do you invest in ETFs? If so what is your experience of them?

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