Exchange Traded Funds (ETFs) Frequently Asked Questions (FAQs) at Nasdaq.com
- Where and how do I buy ETFs?
- Do any ETFs try to beat the market?
- What are the pros and cons of ETFs?
- Are ETFs only for stocks?
- Are ETFs guaranteed or insured?
- Are there currency ETFs?
- Are there hedge fund ETFs?
- How can I short an ETF?
- What is the difference between ETFs and Closed End Funds?
- Do ETFs always pay out the full dividend of all its constituent stocks?
- Are there any Dow Jones Industrials or S&P 500 ETFs?
- Why would I buy an ETF when I can get an index mutual fund without a broker?
- Why would I try to match the market with an index fund when I can beat it with an outperforming mutual fund?
- How do I go about identifying ETFs which are breaking out, breaking down, trending up or trending down?
- How can I find the P/E ratio of the index underlying an ETF?
- Can non-US citizens own ETFs?
- 1. Where and how do I buy ETFs?
- Exchange-traded funds are purchased or sold in share amounts (like an individual stock) rather than dollar amounts that are common in the mutual fund world. You can buy or sell an ETF at any brokerage firm that offers access to these investment vehicles. Many brokerage companies now offer a select menu of "transaction-free" funds that are available to be purchased without an embedded trading costs. This can be advantageous for smaller accounts or investors that tend to trade more frequently. Keep in mind that these transaction-free funds are typically subject to minimum holding periods that are determined by the brokerage company.
- 2. Do any ETFs try to beat the market?
- Quite a few fundamental (or enhanced, semi-active) ETFs try to beat a passive index by tweaking its definition. But the result is still a methodical index with rules-based construction criteria.
There are a limited number of active ETFs that allow a fund manager the leeway to subjectively choose individual stocks or bonds in the underlying portfolio. While no doubt some managers are better than others at stock picking, in practice it is difficult to tell the talented from the merely lucky. Furthermore, actively managed ETFs often carry much higher fees relative to their passive counterparts, which eat into performance quickly.
- 3. What are the pros and cons of ETFs?
- The biggest advantages of getting into ETFs versus investing in mutual funds or stocks include:
- • Lower cost management fees
- • Low fixed transaction costs
- • Transparency
- • Flexibility
- • Convenience
- • Tax efficient
- • Instant pricing
- • Global investment menu
On the other hand, some of the features which are advantages for most investors can be unattractive for certain others. Fixed transaction costs, which are low for investors buying large dollar amounts of ETFs, become relatively high for investors buying small dollar amounts at a time. Therefore, any investor buying less than $1,000 worth of ETFs at a time should consider buying a transaction-free ETF or mutual fund. Likewise, flexibility is good for some investors, but investors with poor judgment and discipline might outthink themselves by making too many moves, and there are fewer restrictions to owning or trading ETFs.
- 4. Are ETFs only for stocks?
- No. Any asset class that has a published index and is liquid enough to be traded daily can be made into an ETF. Bonds, real estate, commodities, currencies, and multi-asset funds are all available in an ETF format.
- 5. Are ETFs guaranteed or insured?
There seems to be little risk of abuse in the ETF structure as an investment vehicle. In the United States, the Securities and Exchange Commission (SEC) thoroughly examines any application to create an ETF, and only large and closely watched firms are allowed in on the daily creation and redemption process of ETF shares. Furthermore, the same government agency (the Depository Trust Clearing Corporation) that ensures individual stock certificates end up in the right investor's hands after a trade also ensures ETF certificates are assigned correctly in a trade.
The risk of price changes in the underlying assets that make up the ETF index is quite another matter. Each asset class must be examined separately, and risk profiles of assets may change over time. Stocks have different risk characteristics than bonds, real estate, or cash. Investors must consider these nuances and risks before they decide to invest and should read the prospectus from the issuer prior to purchasing an ETF.
- 6. Are there currency ETFs?
- Yes, indeed, Guggenheim Investments CurrencyShares line of ETFs track the Euro, British pound, Canadian and Australian dollars and a few others. The funds earn modest short-term interest as well. We recommend that you visit our individual analysis area and search for the individual currency you are seeking for the latest information on this topic.
- 7. Are there hedge fund ETFs?
- There are several ETFs designed to track indexes based on the top holdings of the world's largest hedge funds or billionaire investors. These quasi-active ETFs screen the quarterly filings of hedge fund holdings to determine the most favored positions. This information is publicly available to all investors through the SEC. Keep in mind that these are still index-based products with constraints on how they are built and they may not perform any better than a passive benchmark.
- 8. How can I short an ETF?
- Just call your broker. Most ETFs advertise that they can be shorted, but often there is a limit on the number of shares that are available to be sold short at any given time.
- 9. What is the difference between ETFs and Closed End Funds?
Sometimes the two investment vehicles are confused because they trade on similar exchanges and use comparable terminology. An ETF follows a designated index or benchmark very closely. These funds create and redeem shares throughout the trading day to stay in lock-step with the net asset value (NAV) of the ETF's underlying holdings.
A closed-end fund is a diversified basket of stocks or bonds with a fixed number of shares (like an individual stock). As such, the market price of these funds can float in relation to their NAV to trade at a significant premium or discount. These vehicles are actively managed and often use leverage or sophisticated trading strategies within their portfolios. They also tend to have very high dividend yields that are magnified with the use of leverage. Keep in mind that closed-end funds often have much higher management fees than a passively managed ETF.
- 10. Do ETFs always pay out the full dividend of all its constituent stocks?
- Yes, ETFs always collect the full dividend of all constituent stocks and 'pay out' the dividends to the ETF shareholder. This can be in the form of a cash distribution or a reinvestment in additional fractional shares of the ETF. Either way, the ETF investor receives full payment for all dividends from the underlying stocks or bonds.
- 11. Are there any Dow Jones Industrials or S&P 500 ETFs?
- Yes, there are numerous funds that track these and other popular indexes. Remember that Dow Jones and Standard & Poor's maintain their respective indexes, and that fund groups license the indexes so that more than one ETF can end up tracking the same index. ETF providers can list their funds with varying annual management fees as well. Purchasing the fund with the lowest embedded cost may add to your long-term results.
- 12. Why would I buy an ETF when I can get an index mutual fund without a broker?
- You can certainly buy a mutual fund directly from a fund group at no "load" or sales charge. However, annual management fees will typically be higher with a traditional mutual fund compared to an index-based ETF and you can only buy or sell at the closing price at the end of the day. ETFs offer greater flexibility in trading and investors know exactly what the underlying holding are when they purchase them.
- 13. Why would I try to match the market with an index fund when I can beat it with an outperforming mutual fund?
- First, the question presupposes that a mutual fund that has outperformed a market in the past will continue to do so in the future. Numerous studies by unbiased university researchers have shown clear evidence that mutual funds with leading performance records are just as likely to underperform than outperform the market several years into the future. Many investors have concluded that they are better off not taking the risk and instead remain happy with the market returns of an index fund. Second, actively managed funds inevitably have higher annual management fees and often have a worse capital gains tax profile.
- 14. How do I go about identifying ETFs which are breaking out, breaking down, trending up or trending down?
- Big question and an even bigger challenge. Breakouts and trends are a form of technical analysis, and there are many books on this topic as well as online resources. The evidence for any benefit at all to charting or technical analysis is indecipherable, say researchers. That said, a particularly gifted person can always prove the average wrong. Charts can be quite helpful for long-term investing when used in conjunction with fundamental data to discover signs of value or risk, but not short-term breakouts or trends.
- 15. How can I find the P/E ratio of the index underlying an ETF?
- Sometimes index providers give out this information on their website. Typically, ETF providers give out P/E ratios on their website as well. This is useful for comparing the fundamental attributes of a group of stocks and may be applicable for some investors.
- 16. Can non-US citizens own ETFs?
- ETFs are available in most developed nations. In the United States, anyone who can open a brokerage account and buy stocks will be able to purchase ETFs.