What You Need to Know About…
Exchange-Traded Funds

Exchange-traded funds (ETFs for short) have only recently begun to draw fast-growing investor interest nationwide, but the concept has been around for quite a while. In 1993, the American Stock Exchange began offering the first ETF in the United States, the SPDR 500 Trust (often called the Spider). It allows the investor to closely mirror the entire S&P 500 with a single security. Most U.S. ETFs continue to trade on the Amex—including the most actively traded ETF today, the Nasdaq 100 Trust, known by its distinctive ticker symbol, QQQ.

An ETF is an index fund that trades on an exchange like a stock; as with a stock, it can be bought and sold at any time, and its price fluctuates throughout the day. If you buy it, you do not get professional management: the ETF attempts to track the related index or basket of securities. On the other hand, you also don’t pay for professional management. The annual costs of ETFs are often substantially lower than the costs of managed funds.

Another potential advantage of ETFs is that large institutional investors can purchase or redeem “creation units” of an ETF, in large blocks at net asset value, through contributions or redemptions of in-kind baskets of the fund’s underlying stocks, with very little transfer of cash. So there is little or no need for the ETF to raise cash to meet redemptions. That means that there are few or no taxable capital gains to report at year end, and there is generally little divergence between an ETF’s net asset value and its market price.

The main disadvantage of ETFs concerns the investor who uses dollar-cost averaging to invest through small periodic purchases. Buying and selling ETFs will trigger commissions the same as buying and selling stocks, so small, frequent transactions are not as economical in ETFs as in the many managed funds, or traditional index funds, that offer such programs.*

But for the buy-and-hold investor, ETFs can deliver substantial diversification at low cost. Through a selection of ETFs in various sectors of the market—large-capitalization growth, small-cap growth, large- and small-cap value, and international, for example -- you can use ETFs to rebalance your portfolio every year or so, taking advantage of the way these sectors move relative to one another.

For information on whether exchange-traded funds can help you pursue your financial goals, talk with your financial advisor.

Exchange-traded funds are subject to risks similar to those of stocks. Investment returns may fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost. Exchange-traded funds seek investment results that, before expenses, generally correspond to the price and yield of a particular index. There is no assurance that the price and yield performance of the index can be fully matched.

* A periodic investment plan such as dollar-cost averaging does not assure a profit or protect against a loss in declining markets.

The accuracy and completeness of this article are not guaranteed. The opinions expressed are those of the author(s) and are not necessarily those of David A. Noyes & Company or its affiliates. The material is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Provided as a courtesy by the investment professionals at David A. Noyes & Company.

[Back to list of articles]

Learn more.
To find out more about how David A. Noyes & Company can help you build your wealth, contact us today.