Advantages Of ETFs.

I am always asked about the advantages of using Exchange Traded Funds. Here is a quick amended primer sourced from "Investopedia". I will highlight in Red what are my own points.

It was State Street Global Advisors that launched the first exchange traded fund (ETF) in 1993 with the introduction of the SPDR. Since then, ETFs have continued to grow in popularity and gather assets at a rapid pace. The easiest way to understand ETFs is to think of them as mutual funds that trade like stocks.

Trades Like a Stock. The easiest way to highlight the advantage of the ETF trading like a stock is to compare it to the trading of a mutual fund. Mutual funds are priced once per day, at the close of business. Everyone purchasing the fund that day gets the same price, regardless of the time of day their purchase was made. The ETF's stock-like quality allows the active investor to do more than simply trade intraday. Unlike mutual funds, ETFs can also be used for speculative trading strategies, such as short selling and trading on margin. In short, the ETF allows investors to trade the entire market as though it were one single stock. Most important because ETFs trade like stocks they can also be valued like stocks. Therefore a game plan can be put into work regarding their usage.

Low Expense Ratios: ETFs offer all of the benefits associated with index funds- such as low turnover and broad diversification (not to mention the often-cited statistic that 80% of the more expensive actively managed mutual funds fail to beat their benchmarks) - plus ETFs cost a lot less.

Diversification: ETFs come in handy when investors want to create a diversified portfolio. There are hundreds of ETFs available, and they cover every major index and sector of the equities market. There are international ETFs, regional ETFs and country-specific ETFs. Specialized ETFs cover specific industries (technology, biotech, energy) and market niches. ETFs also cover other asset classes, such as fixed income. While fixed-income ETFs are often selected for the income produced by their dividends, some equity ETFs also pay dividends. These payments can be deposited into a brokerage account or reinvested.

Asset Allocation: Studies have shown that asset allocation is a primary factor responsible for investment returns, and ETFs are a convenient way for investors to build a portfolio that meets specific asset allocation needs. For example, an investor seeking an allocation of 80% stocks and 20% bonds can easily create that portfolio with ETFs. That investor can even further diversify by dividing the stock portion into large-cap, growth and small cap value stocks, and the bond portion into mid-term and short-term bonds.

Tax Efficiency: ETFs are a favorite among tax-aware investors because the portfolios that ETFs represent are even more tax efficient than index funds. In addition to offering low turnover - a benefit associated with indexing - the unique structure of ETFs enables investors trading large volumes to receive in-kind redemptions. This means that an investor trading large volumes of ETFs can redeem them for the shares of stocks that the ETFs track. This arrangement minimizes tax implications for the investor exchanging the ETFs since the investor can defer most taxes until the investment is sold. Note however that investors would be responsible for gains as well as losses incurred when they individually sell an ETF in a taxable portfolio. However, ETFs make possible under certain circumstances tax harvesting advantages that might not be available by purchasing individual securities.

Conclusion: The reasons for the popularity of ETFs are easy to understand. The associated costs are low, and the portfolios are flexible and tax efficient. The push for expanding the universe of exhange-traded funds comes, for the most part, from professional investors and active traders. Nevertheless, long-term investors will find that the broad-market based ETFs can find a place in their portfolios when they have an opportunity for occasional large-size purchases of securities. Investors interested in passive fund management, and who are making relatively small investments on a regular basis, are best advised to stick with the conventional index mutual fund. The brokerage commissions associated with ETF transactions will make it too expensive for those people in the accumulation phase of the investment process.

Source except where noted above in Red: "Investopedia". http://www.investopedia.com/articles/mutualfund/05/060605.asp?viewed=1