Exchange-traded funds, or ETFs, are built with a basket of stocks that track a particular index, such as the S&P 500 Index or the Russell 1,000 Index. When you buy an ETF, you buy an index fund that tries to match the performance of that index. Most ETFs are passive trading tools that try to match rather than beat an index.
ETFs offer you a number of advantages:
Minimal managerial risk: The fund manager makes only minor periodic adjustments to keep the fund in line with its index, which mitigates the element of managerial risk. You’re harnessing the power of the index you choose.
Fewer management fees: Because trading is minimal, the management costs of ETFs are low, so less of your money goes toward fees.
Diversity: You get the benefits of diversification, so you’re not dependent on just one or two stocks in a sector that you need to research and then monitor.
Trading flexibility: They’re traded just like stocks. You can buy and sell ETFs throughout the trading day. Rapid trading triggers no penalties.
You can use market orders, limit orders, stop orders, and stop-limit orders. And, unlike a traditional mutual fund, you can short shares of
an ETF. They can also be bought on margin. (Read Chapter 15 for the mechanics of selling short.)
High volumes: They’re typically traded at much higher volumes than individual stocks, which means you can count on high liquidity, making
it easy to buy and sell when you want.
You can find ETFs for any sector you want. You can also find ETFs that match the market cap you want, such as small-, mid-, large- and mega-cap companies. You can use them to trade commodities or currencies. Although you may not have difficulty finding an ETF that tracks exactly what you want, you do need to understand how that ETF builds its portfolios
What Is an ETF