What Is An ETF?

ETF stands for Exchange Traded Funds — these are funds that trade on the stock exchange just like any stock. And you follow the same procedure at your online broker to buy an ETF as you would any stock like IBM or GE. It should cost you between $4 and $10 per trade.

ETFs are not a secret, but investment professionals often don’t make fees from them, so they often go ignored.

Each ETF is a “basket” of stocks that represent a particular index. For example if you wanted to own every stock in the S&P 500 Index, you would by one of several ETFs that follows that index – an example being “SPY” or Spiders. By owning one share of SPY, you gain diversification across 500 stocks.

With ETFs you can invest in practically any market you want. Some of the most popular indexes are the S&P 500 (tracks the largest U.S. public companies), the Russell 2000 (tracks some of the smallest U.S. public companies) and the Morgan Stanley Europe Asia Far East (EAFE) index composed of companies in developed foreign countries. ETF investing also allows you to invest in real estate, bonds, commodities, sectors and other markets. There are currently over 800 ETFs now available and growing.

Mutual funds are 6 -10 times more expensive than ETFs because they hire pros who try to select a few stocks within the index that will “beat” it. But when you invest in an index fund, you basically get the exact returns of the index. Since computers (not humans) manage the stocks in an ETF, the fees are very low.

Sit back and let it ride — To allow the Law of Compounding to work its magic, it’s important to hold your ETFs as long as possible so you pay minimal taxes on dividends. And really, unless you decide to get out of a market, there are few good reasons to sell. Better to hold on and ride the markets, continuing to enjoy the benefits of Law of Compounding at rates that have averaged around 9% a year through history for stocks and 5% for bonds.

Still yearning for the excitement of individual stocks or “high-flying” mutual funds? If you’re determined to beat the house, you might as well go to Las Vegas. It has nicer hotels than Wall Street for nursing your financial wounds.