What Are Exchange Traded Funds (ETF’s)?
At first glance, an ETF may look similar to a mutual fund. But this could not be further from the truth.
Exchange-Traded Funds (ETF’s) are a simple and effective way to invest in nearly every imaginable market segment, industry, index, or even the global stock market.
There is currently a considerable variety of ETF’s which are designed to track the performance of any of the following:
- A stock market index – The S&P500 (Ticker SPY)
- A commodity – Gold (Ticker GLD), Silver (Ticker AGQ)
- An Industry – Global Telecoms Sector (Ticker IXP)
- Size of Stocks – Small Cap Value (Ticker VBR)
- A Country – Russia Bull (Ticker RUSL)
- A Currency – British Pound Trust (Ticker FXB)
- Futures Contracts – (Short Term S&P500 Futures (Ticker VXX)
ETF’s trade like a stock on the open market; this is beneficial as it means a good level of liquidity and lower transaction costs. As with any financial transaction, you need to know the character of the instrument you are using.
Directional Investing with ETF’s
ETFs can also be used to trade in the direction you wish.
BULL ETF – An ETF with the word “Bull” indicated in the name means the fund will be profitable if the underlying assets increase in value.
BEAR ETF – An ETF with the word “Bear” or “Inverse” in the name indicates that if the underlying assets decrease in value, you will make a profit.
Leveraged investing with ETF’s
ETF’s are also designed to provide you leverage built-in. If a fund has the term 2X or 3X in the name, it means the fund will attempt to replicate the movement of the underlying assets but magnify the gains by twice as much or three times as much.
For example, if you believe the stock market and, in particular, the S&P 500 is going to pull back (go down) over the next three months, you may decide to purchase the Rydex 2x Inverse S&P500 ETF (Ticker RSW).
The 2X refers to the fact that the ETF managers seek to emulate a two times return based on the price movement of the underlying assets.
So, if the market goes down 5% and you own a 2X Inverse ETF, you should then expect to profit by 10%.
If you had a standard 2X ETF that was not inverse and the market went down 5%, you would lose 10%
With all ETF’s the caveat is they “seek to emulate,” this means it is not always a perfect science, especially with the bear market funds. Some ETF’s do the job better than others. Do your research.
An example, from August 2011, the market went into a short term correction, meaning the market went down. This table shows some of the best performing ETFs during the market decline.
This is a list of the ETF’s with the best percentage gains over a 30 days period. They are also filtered so that ETF’s with a capitalization of less than $200 million are excluded. This filtering helps to ensure that there is enough liquidity in the trades to enable easier entry and exit.
Exchange-Traded Notes (ETN’s)
The ETN is similar to the ETF as it trades openly on the stock exchanges; however, its underlying characteristics are different. It is a hybrid of an ETF combined with the debt ownership of Bonds.
For example, you may hold an ETN to maturity, and at that point, you will be eligible to receive a cash payment equivalent to the principal value of the note.
PODCAST – The power of Exchange Traded Funds – Good or Bad?
Take a look under the covers of Exchange Traded Funds (ETFs), should you have them in your portfolio of assets?
- PublishedSun, 18 Feb 2018 23:00:00 GMT
- Duration 00:13:08