EXCHANGE-Traded Funds (ETFs) are created from the concept of pooled fund investing. ETFs buy a basket of securities for a pool of investors. These baskets offer benefits of a diversified portfolio. In other words, the pooled fund concept benefits from economies of scale, allowing managers to decrease transaction costs through large transactions with pooled investment capital. ETFs also allow you to buy stocks that you wouldn’t be able to afford on your own.
ETFs come in three flavors: traditional, niche and exotic
1. Traditional ETFs are what most investors have in mind when they think of ETFs. These are low-cost, tax-efficient funds (most with annual expenses of 0.35% or less) that provide access to a broad range of securities in an asset class such as large US stocks, small US stocks, international stocks, or investment-grade bonds. Traditional ETFs are useful tools for inexpensively diversifying your portfolio, and they are available in all major asset classes.
2. Niche ETFs are similar to traditional ETFs except that they focus on a narrow slice of a broader asset class. Niche ETFs invest in individual sectors like health care, single countries like France, or narrow parts of the bond market like high-yield bonds. They tend to have somewhat higher expenses than traditional ETFs. Niche ETFs can be useful for completing a well-diversified portfolio, providing access to a part of the market that you’re not getting from your individual security holdings. However, it can be tempting to use niche ETFs for speculating on narrow market segments, which can be risky.
3. Exotic ETFs provide access to unusual asset classes or investment styles, typically at a premium price by ETF standards (annual expenses often over 0.75%). Exotic ETFs include commodities such as gold, concepts such as clean technology, or leveraged securities that move twice as much as the market or directly opposite the market. Although exotic ETFs might seem exciting, it is important to make sure that you fully understand the nature of the fund before investing, as exotic ETFs tend to be very different and often more volatile than traditional investments.
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Victor Santos Sy graduated Cum Laude from UE with a BBA and from Indiana State University with an MBA. Vic worked with SyCip, Gorres, Velayo (SGV – Andersen Consulting) and Ernst & Young before establishing Sy Accountancy Corporation in Pasadena, California.
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He has 50 years of experience in defending taxpayers audited by the IRS, FTB, EDD, BOE and other governmental agencies. He is publishing a book on his expertise – “HOW TO AVOID OR SURVIVE IRS AUDITS.” Our readers may inquire about the book or email tax questions at [email protected].