WHAT IS AN EXCHANGE TRADED FUND (ETF)?
Any stock investor will, sooner or later, hear people talking about ETF’s. If you want to buy stocks and learn about investing in the market, you have to learn the lingo and there sure is a lot of it. Besides the symbols of every company in the Dow, there are initials that stand for other things such as the ETF which stands for exchange traded fund. The stock market game is full of abbreviations, symbols, and initials that can be quite baffling for a beginner.
ETF’s are a group of stocks (often called a basket of stocks) that are related in some way. Usually they are related because they are in the same industry. For instance, if you would like to invest in a group of retail stocks, you can buy the exchange traded fund XRT. That fund has a group of just under 70 stocks in it that are all retailers and the individual stocks in the group rarely change. ETF’s represent an index and they are a way you can easily invest in an industry without having to agonize over what individual stocks to buy.
ETF’s are traded exactly like a stock and you can buy and sell them any time the market is open – their price changes all day long. This is different from mutual funds that are usually only priced at the end of every day’s trading session. Another difference between ETF’s and mutual funds are the cost. Exchange traded funds are cheaper than mutual funds because they have no manager managing the money and constantly figuring out what stocks to buy and sell and when to do it. With ETF’s, you get your group of stocks and those stocks stay the same because they are never switched out for other companies.
No matter what industry you are interested in investing your money, there is probably an ETF for it. Health care, energy, oil, gold, technology, financial, and many other industries all have exchange traded funds that you can buy just as easily with any online broker just like you would buy stocks. If you like a certain sector of the economy, buying an ETF can definitely be easier than sitting down and trying to figure out what company to buy within that sector.
Let’s continue on with our XRT example which is the retail ETF. The Christmas shopping season is now in full swing and we will be hearing stories in the news every night about sales, how much people are spending, what is selling well, and so on. Is it too late to buy retail stocks and get in on the action?
If we wanted to place a bet on the whole retail industry, the best way to do that might be to buy XRT which has a cross section of many retailers in it. That way we wouldn’t have to try to figure out what retailer was going to have the best sales this year. Will it be Walmart, Nordstrom, Best Buy, or Apple? With the exchange traded fund XRT we would be investing in the whole retail sector with one easy stock buy and we wouldn’t have to make any other decisions. Simple right?
Looking at the chart of XRT below though, you can see that it has had a HUGE run up from September of 2010 and it looks like it might be too late to buy retail stocks this year. Remember, people buy stocks early in anticipation of what they think is going to happen and it looks like lots of people have already decided to invest in retail thinking this is going to be a pretty good holiday shopping season.
