Understanding The Basics of Exchange-Traded FundsSubmitted by LWM | Linden Wealth Management LLC on May 19th, 2021
Thinking about where to invest your money can be overwhelming and confusing, especially for those unfamiliar with all investing options. If you'd like to take advantage of the ease of stock trading with the diversification of mutual funds, exchange-traded funds (ETFs) can potentially give you the best of both worlds. Here are some key things to know about ETFs before investing.
An Exchange-traded fund (ETF) is a basket of securities that trade on an exchange, just like a stock. They can contain all types of investments including, stocks, commodities, or bonds. They can be passive, following an index, or active, based on the discretion of the asset manager. In many ways, they're considered a more modern version of the traditional mutual fund.
ETFs vs. Mutual Funds
One of the advantages of investing in an ETF is the diversification of funds without investing in each asset individually. In this respect, ETFs are similar to mutual funds, with a few key exceptions.
First, ETFs are traded on an exchange throughout the day, much like stocks. Mutual funds, on the other hand, are traded just once per day after the markets close. The price of an ETF could change throughout the day, again like a stock, but a mutual fund's price will update daily at the market's close.
There may also be lower costs and more tax-efficiency advantages to investing in an ETF versus a mutual fund. For the most part, ETFs are tracked passively, which means management and operational costs are generally low. And compared to mutual funds, there is less turnover for ETFs. Less buying and selling of assets results in fewer capital gains and greater tax efficiency. Additionally, investors in ETFs are only taxed upon selling their investment, whereas mutual fund investors incur a tax burden throughout the life of their investment.
Lastly, ETFs have greater transparency than mutual funds. Anyone can access the price activity for an ETF, and the fund's holdings are disclosed each day to the public.
As with any investment, it's a good idea to talk to a financial professional before committing funds to ensure that it is appropriate and suitable for your investment goals, objectives, and risk tolerance.
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