Exchange-traded funds, or ETFs, are typically passively-managed, index-based investment funds that trade like stocks on major domestic and international stock exchanges. ETFs hold assets such as stocks or bonds and seek to trade at approximately the same price as the net asset value of their underlying assets.
ETFs offer investors certain potential advantages over actively-managed mutual funds:
- Diversification - Since most ETFs track indexes that are made up of a basket of securities, they can provide instant diversification to their shareholders.1
- Real-time pricing and liquidity - Unlike mutual funds, which are priced only at the end of every trading day, ETFs are priced on virtually a real-time basis throughout the day. As publicly traded securities, they can be bought, purchased on margin or sold short.
- Transparency2 – ETFs generally disclose their holdings on a daily basis, so you always know exactly what you own.
- Low expense ratios – Most ETFs carry expense ratios that are generally lower than those of many actively-managed mutual funds. Normal brokerage fees do apply.
- Tax advantages3 – Since most ETFs are based on underlying indexes, they generally have lower portfolio turnover than many actively-managed mutual funds. What’s more, they allow investors to pay most of their capital gains upon final sale of the ETF, thereby delaying the tax consequences of owning the position until termination. By contrast, mutual funds generally periodically distribute capital gains to their investors, who must then address the tax consequences. While the overall tax efficiency of an ETF is a function of such factors as an investor’s particular tax rate and the return the investment produces, the tax benefits of an ETF can be significant when compared to mutual funds, especially actively managed funds.4
The history of ETFs dates back to 1989, when an early prototype tracking the performance of the S&P 500 Index was made available to investors on the American and Philadelphia Stock Exchanges. But it was the introduction in 1993 of Standard & Poor’s Depositary Receipts (SPDRS) – or Spiders (or Spyders), as they are better known – that presaged the emergence of the category.
Today, there are more than 1,000 different ETFs5 offered by scores of providers and covering virtually every imaginable investment area – from large-cap domestic, European and Asia-Pacific stocks in all asset classes to high-yield, government and world bonds to precious metals, commodities, real estate, technology and virtually every other asset class.
1Diversification does not eliminate risk.
2Portfolio holdings are disclosed daily at www.esgshares.com.
3ESG Shares ETFs are not managed with an objective to avoid capital gains distributions.
4This information is provided for informational purposes only, and should not be considered tax advice. Please consult your tax advisor for further assistance.
5Source: Morningstar, 12/31/10.
ETFs are subject to risks similar to those of stocks, including those regarding short-selling and margin account maintenance. Ordinary brokerage commissions apply.