Exchange-traded funds (ETFs) have grown in popularity. In the past, professionally managed mutual funds and individual stocks or bonds were the only ways to invest. An ETF is a basket of investments that is designed to mirror an index or benchmark. Over a dozen different investment companies offer ETFs in various styles and strategies.
Unlike mutual funds that are bought or sold at the end of trading day, ETFs trade instantly on an exchange. Much like a stock, ETFs have current bid and ask prices, reflecting whether the price is trending up or down during the day. You can purchase ETFs through a larger brokerage firm such as Merrill Lynch or an online firm such as E*Trade Financial Corp. (NASDAQ: ETFC). ETFs do not have an upfront or ongoing sales charge like a mutual fund, but they are bought and sold on a commission or advisory flat-fee basis. However, ETFs do have expense ratios, which are internal expenses.
How to Trade ETFs
Trading an ETF is very similar to trading a stock on any major stock exchange. The first step is to find a broker to facilitate the trade. Large brokerage firms such as Merrill Lynch or Morgan Stanley (NYSE: MS) can facilitate the trading of an ETF. Larger firms may charge a high commission or an annual advisory fee.
If you want to buy an ETF at a low cost, a discount online brokerage firm would be the best option. Companies such as E*Trade or Scottrade offer trading at a discount. Purchasing or selling an ETF on Scottrade's website costs $7, as of June 2016. E*Trade is a little more expensive for the same purchase, charging $9.99 per transaction. Many online brokerage firms run promotions, such as free or discounted trading for a trial period.
When buying or selling an ETF, the transaction should go through immediately based on the average trading volume. ETFs continue to increase in popularity, increasing the trading volume. However, some lesser-known ETFs that have little to no volume might need to be bought or sold using limit orders to minimize inaccurate price discrepancies.
Selecting an ETF
There are many different styles and types of ETFs on the market. The most commonly traded ETF is the SPDR S&P 500 ETF (NYSEARCA: SPY). This fund is designed to mirror the movements of the Standard and Poor's (S&P) 500 Index and has done so at a net expense of 0.09%. This ETF would be suitable as a simple, diversified option to invest in U.S. stocks.
There are plenty of options if you're looking to drill down to more specific sectors or industries within the ETF market. For example, the Financial Select Sector SPDR Fund (NYSEARCA: XLF) tracks the movements of the financial sector of the S&P 500 and invests in banks, insurance companies, and real estate.
ETFs are not just limited to investing in stock indices. There are plenty of fixed-income ETFs available. Owning international stocks is often a complicated tax issue, so it is more convenient to purchase an international-style ETF. Since these funds are traded on a U.S. stock exchange, no foreign tax passes on to investors.
ETFs are a practical solution if you're seeking alternative investments. Gold is a common investment and is used as a hedge against the market in times of volatility and inflation. However, buying actual gold is difficult, and you need to store and care for it properly. If you're seeking exposure to the gold market, you could invest in the VanEck Gold Miners ETF (NYSEARCA: GDX). Rather than investing directly in gold, this fund's portfolio consists of stocks of gold mining companies. These companies' stocks are highly correlated with the price of gold and investing in this ETF grants exposure to the commodity.