investing

What are exchange-traded funds?

 

Thinking about investing? Exchange-traded funds are becoming a top choice among investors on both Wall Street and Main Street. But what are they?

Otherwise known as ETFs, exchange-traded funds are hybrids between stocks and mutual funds.

They’re popular because of:

  • Trading flexibility.
  • Lower operating costs.
  • Favorable tax characteristics.
  • And most of them track broad market indexes.

This makes them well-suited for long-term investors who may otherwise be interested in mutual funds.

ETF prices fluctuate throughout the day, making them a good match for more active investors. And some newer ETFs lend themselves to short-term tactical strategies as well.  ETF investors won't incur a tax gain or loss until they sell their investment, unlike mutual fund investors, who generally get a tax bill at the end of the year as a result of trading activity within the fund.

Another big difference between ETFs and mutual funds is that ETFs are bought and sold like stocks on an exchange, such as the New York Stock Exchange. On the other hand when you own shares in most mutual funds, you redeem your shares through the mutual fund company when you want to sell them.

One downside of ETFs is the brokerage commission you’ll pay when you trade, so active investors should search for ETFs that can be bought and sold commission-free. Another fee associated with ETFs is the expense ratio -- the cost of running the fund -- which tends to be lower than those on mutual funds, especially actively managed mutual funds.

Before you invest in anything, think about your personal investment strategy. Instead of asking, “What ETFs have been doing well lately?” determine how you want to design your investment portfolio, and then choose the ETFs that fit those parameters.

For more information to determine if ETF investing is right for you, visit Bankrate.com.

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