An ETF, or Exchange Traded Fund, is a relatively new addition to the investing world. Like a mutual fund, it invests in a variety of stocks, but it is bought and sold more like a regular stock than a mutual fund. Most ETFs track an index, or group of stocks. ETFs that track an industry sector are also now available.
The great advantage to adding an ETF or two to your portfolio of stocks is that it adds instant diversification, which protects the investor against losses generated by problems within one company. Dividends earned by the stocks within an ETF are paid to the investor quarterly.
The first of the ETFs was Standard & Poor’s Depositary Receipts (AMEX symbol: SPY), which was launched in 1993. It tracks the stocks in the Standard & Poor’s 500. The S&P 500 tracks 500 large cap US stocks. This ETF is often the first one an investor will consider purchasing as it very well tracks the economy in general- which is, admittedly, more popular when the economy is doing well. (Disclaimer: I have a few shares of SPY myself, so don’t just take my word on it, do your own research because I can and do make mistakes.)
Another important ETF is DIAMONDS Trust Series I (symbol: DIA). This ETF tracks the thirty stocks of the Dow Jones Industrial Average. These stocks include some of the best known companies in the US.
For the dividend investor, a number of funds which invest in an index of high-dividend paying stocks may be attractive. A list of dividend ETFs may be found at http://www.etfscreen.com/s_div.php. and ETFs of all sorts may be researched at http://www.etfscreen.com/index.php and http://www.thestreet.com/.
Research is essential before investing in an ETF. One of the problems in trying to research an ETF is the fact that ETFs are new, and some of them are very new, and don’t have much of a track record to look at. One thing to look at is the top stocks owned by the ETF. At Sharebuilder.com, which is where I buy my stocks and ETFs, they give you the top ten stocks for each ETF along with a graph of the industry sectors they represent.
Some financial experts are critical of ETFs, saying that most are not diversified enough and that the trading costs incurred by the ETF cut into the earnings too much. Another problem is that there are so many ETFs to choose from that it may confuse the investor- but the same thing may be said of individual stocks and of mutual funds.
ETFs, although new and in the opinion of many unproven, may rate serious consideration by the investor because it so easily adds the factor of diversification to your investment program.