Overview of stock ETF trading and investing. Exchange Traded Funds, or ETFs, are a different kind of investment asset which combines the flexibility and liquidity of stock ownership with the diversification of a mutual fund. They do this with generally lower overall costs than mutual funds making them even more attractive.
For the end user they have a number of similarities and differences. I’ve summarized them in the table below:
The primary practical advantage of ETF investing over a particular stock is similar to that of a mutual fund, covering your investment with the blanket of diversification as opposed to relying on doing due diligence on specific companies. Many are ready-made portfolios of stocks in a particular sector.
Commodity ETFs can act as a way to over-weight in a sector that is particularly bullish. For example, buying both GLD to take advantage of the swings in the price of gold while also buying a handful of gold mining companies, or the GDX ETF, would have been a good strategy in 2011 as the metal outperformed the mining sector.
They do, however, have some fundamental differences than stocks. Many have holding costs associated with them. If they pay dividends, then these costs are subtracted from the dividend dispersal. Some ETFs hold foreign securities or foreign currencies and these dividends are subject to tax withholding up front (15% in the U.S.) but can be recovered when filing your income tax.
As the table suggests ETF trading can be just like a normal stock trading, selling it short or buying it on margin. In fact some ETFs are so-called ‘Short ETFs’ where buying a share of the ETF is the equivalent of going short the market and vice versa.
Options can be written and sold versus ones ETF holdings just like a normal stock as well. Options trading is inherently more aggressive than buying the stock directly, using 100:1 leverage. Some ETFs are designed to be leveraged as well, aiming to double or triple the volatility of the market of which they are a proxy.
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