Benefits of Investing in ETFs
What is an ETF? An exchange traded fund is a group of securities that have been grouped together based on their individual characteristics such as cost, yield, index membership, and maturity. An ETF usually has the same composition as the broader category of securities (known as the underlying). ETFs are not traded on traditional exchanges like the New York Stock Exchange or the NASDQ. Instead, they are usually traded on over-the-counter marketplaces like the OTCBB or Pink Sheet.
Why would anyone consider buying ETFs? The most popular reason for investors to consider buying ETFs is to take advantage of the tax advantages that come with mutual funds. When an investor pools funds from several sources he or she will typically pay less in taxes. This is because a portion of each investment that results in a net asset value – i.e., the difference between total assets and the current market price per share – is included in the investor’s gross income. Because ETFs are treated just like ordinary mutual funds, investors must pay taxes only if they sell their shares and they withdraw the money within the year.
However, there are many other advantages to investing in ETFs as well. One major advantage is that ETFs are very low-risk. Unlike actively managed funds, which can be very risky, ETFs trade on generally safe exchanges. In addition, ETFs have the added benefit of being able to reduce the volatility of market prices by utilizing leverage and derivatives and exchanging their portfolio risks for a different type of risk reward, such as dividends. Finally, ETFs can offer a wide array of different types of revenue streams, such as through their own stocks or futures markets, as well as through pricing their securities in different ways. This pricing flexibility makes ETFs ideal for short-term and growth investors who can better manage their risks by owning multiple types of securities and multiple types of trading venues.