What is ETF?
A security that tracks an index, a commodity or a basket of assets like an index fund,
but trades like a stock on an exchange. ETFs experience price changes throughout the
day as they are bought and sold.
NAV
Because ETFs and closed-end funds trade like stocks, their shares trade at market
value, which can be a dollar value above (trading at a premium) or below (trading at a
discount) NAV.
Net Asset Value per share - This is the Net Asset Value of the fund divided among all
the outstanding shares. If the market values the ETF at a higher price than the Net
Asset Value, then it is said to be trading at a "premium". If the market price is under the
fund' s net asset value, then it is trading at a "discount".
Keep in mind that the date and time the assets where measured and the current market
prices for those assets might vary. This is why it is very important to use very recent
figures or at least take price into consideration.
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Dividend - Some ETF's have dividends, so you can decide to choose between two
similar ETF's based on which one pays you a higher dividend. Also, sometimes
dividends are high enough so that the dividends alone could provide a good return
regardless of where the market price of the ETF goes. Dividend safety is key when you
make decisions based of dividend yield. In the resources section I placed a link on how
to determine a dividend's safety.
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Individual holdings valuation - You can always evaluate each of the fund' s holdings and
see if you think the market is over-valuing or undervaluing each individual stock. You
should start with the holdings that occupy the largest percentage of the fund' s allocation
and go from there
ETFs are like mutual funds because they hold an underlying asset like stocks, debt,
commodities future contracts etc. If you are new to the concept of an ETF, think of it as
a mutual fund, and build your understanding from thereon. An example of an ETF is
the SBI Gold ETF, which holds physical gold as its underlying asset.
ETFs charge you for their expenses
It takes money to run an exchange traded fund, and that money is recovered from
investors. All ETFs charge you fee which is expressed as a percentage called: “Expense
Ratio”. The lower the expense ratio, the cheaper the fund is. You should try to compare
expense ratios between different ETFs, as that will tell you how much you have to pay in
fees. All mutual funds do this too, so in this respect ETFs are like mutual funds.
ETFs do not need a minimum investment
Mutual funds have a minimum investment amount, and you need to at least invest that
much in order to get in the fund. On the other hand, ETFs don’t have any such
minimum investment requirement, and you can buy just one unit of an ETF, if that’s all
you want.
ETFs trade all day long on a stock exchange
The above points discussed the similarities between a mutual fund and an ETF. This
point discusses a key aspect in which ETFs are different from mutual funds.
ETFs trade on a stock exchange and can be bought and sold any time during a trading
day. If you have a brokerage account and buy stocks through that – you can buy
ETFs the same way. You can’t trade a mutual fund like this, but can buy or sell an ETF
any time during the trading day. In this respect, an ETF is similar to a stock.
Brokerage on an ETF and stock is equal
Since you buy ETFs like you would buy stocks, the brokerage you pay on both are
identical. The commission that your broker charges for stocks is the same that will be
applicable for buying ETFs.
No loads are charged by an ETF
A lot of mutual funds charge front and end loads, which is nothing but fees that you pay
when you buy or sell the fund. ETFs don’t charge any front or end loads to investors.
You can short an ETF
You can short an ETF if you wanted to. This can’t be done with mutual funds.
ETFs can be traded on a margin
Like stocks – ETFs can be traded on a margin.
Conclusion
ETFs are like mutual funds but offer a lot more flexibility than them. The downside is
that they are easier to trade — and that tempts investors to get in and out quickly
thereby incurring trading costs. All in all this is a useful innovation that opens up one
more avenue for investors to gain exposure to the stock market.
If you want to read more, then here is another post about the differences between an
ETF and in index fund that you may find useful
