ETFs Can Spell Opportunity

Mutual funds offer investors a chance to own shares in dozens of companies, as well as bonds, government securities and other investments. But you might be able to broaden your portfolio further by owning another type of fund — an exchange-traded fund (ETF).

An ETF, like a mutual fund, can own an array of investments, including stocks, bonds and other securities. Many ETFs are passively managed in that they track the performance of a specific index, such as the S&P 500. In this respect, they differ from most mutual funds, which tend to be actively managed — that is, the fund managers are free to buy and sell individual securities within the fund.

Another difference between ETFs and mutual funds is that ETFs are traded like stocks, so shares are bought and sold throughout the day based on the current market price, whereas mutual funds are traded just once a day, at a price calculated at the end of the trading day. Whether this ability to make intra-day trades is meaningful to you will likely depend on how active you are in managing your own investments.

For some people, the main attraction of ETFs is the tax advantages. Because many ETFs are index funds, ETFs generally do much less buying and selling than actively managed funds — and fewer sales mean fewer taxable capital gains. These ETFs are somewhat similar to index mutual funds, which are also considered to be tax efficient, as opposed to actively managed funds, which constantly buy and sell investments, passing on taxable capital gains to you throughout the life of the fund. Mutual funds that trade frequently may still be appropriate for your financial strategy. While taxes are one element to consider when evaluating mutual funds, or any investment, other factors, such as growth potential and ability to diversify your portfolio, are also important.

ETFs typically have lower operating costs than mutual funds, resulting in lower overall fees. Part of the reason for these lower costs is that actively managed mutual funds, by definition, usually have larger management teams devoted to researching, buying and selling securities. By contrast, passively managed ETFs may have leaner, less-costly management structures.

But while most ETFs may share the same basic operating model, many types are available. You can invest in equity ETFs, which may track stocks in a particular industry or an index of equities such as the S&P 500 and Dow Jones Industrial Average, or you can purchase fixed-income ETFs, which invest in bonds. ETFs are also available for currencies and commodities.

As with all investments, ETF investing does involve risk. Your principal and investment return will fluctuate in value, so when you redeem your ETF, it may be worth more or less than the original investment. Also, liquidity may be an issue. Some ETFs may be more difficult to sell than other investments, which could be a problem if you need the money quickly. And because it’s so easy to move in and out of ETFs, you might be tempted to “overtrade” rather than following an appropriate long-term investment strategy.

A financial professional can evaluate your situation and help you determine whether ETFs are suitable for your needs. At a minimum, ETFs represent another investment opportunity that may prove useful as you work toward your financial goals.

Brian Conrad is a certified financial planner and financial advisor with Edward Jones. His office is located at 479 Jumpers Hole Road, Suite 202, in Severna Park. To learn more, call 410-544-8970, email brian.conrad@edwardjones.com or visit www.edwardjones.com/brian-conrad.