by Daniel Xiao Wang

Created on: January 09, 2009   Last Updated: May 12, 2011

Exchange traded funds (ETFs) made a large impact on the financial world when the Spider, the S&P 500 ETF, was introduced in January of 1993. It was not the first fund of this type, but the most notable in the United States. It is the largest exchange traded fund trading today.

Exchange traded funds are very popular investment vehicles for many good reasons. For beginning and experienced investors exchange traded funds make great investments and can help save money.

Exchange traded funds represent a pool of securities, much like a mutual fund. The major difference is that while mutual funds trade at a single value everyday, the net asset value (NAV) determined at the close of business everyday, an ETF trades intraday like any other security.

So an exchange traded fund is a fund that trades like a stock. This makes ETFs more liquid and easier to trade than mutual funds. Also, while some mutual funds are restricted to certain investors, ETF's are public and easily purchased through a broker.  Great accessibility and liquidity are appealing aspects in an investment.

Since an exchange traded fund is a pool of securities owning an ETF is like buying instant diversification. You are immediately diversified over with all the equities wrapped into the fund.

Most ETFs have a lower expense ratio than similar mutual funds as well. This is because exchange traded funds do not have the monetary requirements that mutual funds do, and they do not typically have management fees. In some cases mutual funds have a fee for holding them for too short a term, exchange traded funds have no such fees.

Exchange traded funds do not often change the investments within the fund. Even when they do these changes in securities do not represent a capital gains or loss to the owner of the ETF. This is a great tax saving over mutual funds, where the adjustments in securities constitute a taxable event in many cases.

Exchange traded funds are excellent investments. They provide instant diversification, are very liquid, are traded on an exchange, do not generate additional taxes and have low expense-ratios- saving money. Because they trade on an exchange they also fit into almost any investment strategy an investor may wish to use.

Exchange traded funds can be purchased on margin and shorted. They can have a stop order placed upon them. Whatever strategy you wish to use, an exchange traded fund allows you to pursue that strategy.

Exchange traded funds also allow you to save money by diversifying your investments in a single purchase.  Purchasing a fund saves the transaction fees of purchasing multiple securities.  This is an excellent way to diversify and still save money.

Are exchange traded funds a good investment?

Yes- if you like the idea of diversification without increasing your tax exposure and without limiting your access to your funds while maintaining the freedom to pursue whatever investment strategy you would like.

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