An ETF is an Exchange Traded Fund is essentially a mutual fund (mostly indexed to a particular index. The ETF company just mirrors the index, and doesn't make active stock decisions) that trades on the major exchanges just like a regular stock. You normally buy and sell them and pay commissions. For example, the stock symbol "DIA", isn't really an individual company. The "DIA" ETF represents the Dow Jones Industrial Average ETF. It holds the 30 stocks in the Dow Jones Industrial Average. However, from your point of view, you are buying and selling "DIA" directly, a single trading instrument. You lose money and profit just as if you were holding a single stock.
How do I choose an ETF?
There are many types of ETFs that focus on broad based indices such as the Standard and Poors 500 Index (500 of the United States largest and most influential companies). Or, ETFs could focus particular sectors (such as Utilities), market capitalization (large cap or small cap), countries (Taiwan or Mexico), Region (Asia, or Western Europe), asset class (stocks, bonds, or real estate trusts), or any other combination.
Possible uses of an ETF
1. Your entire portfolio could be made up of ETFs! This is especially useful in retirement or 401k plans, but could be used in your discretionary taxable portfolio if you do not want to spend too much time researching individual stocks.
2. You could allocate much of your portfolio to a broad based ETF portfolio (let's say 70%), and for the other 30%, you can explore and choose individual stocks or sector ETFs. This is called the "Core and Explore" method.
3. You could use ETFs to supplement your portfolio. As an example, let's say you have a well diversified portfolio of individual stocks. However, you are lacking exposure to Retail, but you do not have expertise in retail, and you don't have the time to research or monitor individual retail stocks, so you can purchase PMR, the Proshares Dynamic Retail ETF. Or you may be very good at investing in small cap stocks, so you have a portfolio of individual small capitalization stocks, but you buy the broadbased SPY ETF which has exposure to large cap US stocks.
4. You could use ETFs as a hedge. Proshares has a series of inverse ETFs which increase in value as a sector or index goes down. Roger Nusbaum of TheStreet.com writes an article about hedging with Double Short ETFs.
Major Companies that Provide ETF products and other Resources
- ishares: IShares.com is part of Barclays and they offer a very wide range of ETFs. Very good place to start.
- Vanguard ETFs: Vanguard offers many broadbased and inexpensive ETFs.
- ProShares: Offers inverse and double inverse and double long ETFs and sector ETFs
- PowerShares: Offers unique ETFs that can include ETFs based on company buybacks, or specialized sector ETFs that do not overweight large cap stocks
- SectorSpdrs: Liquid Sector ETFs. Includes interesting Graphic Sector Maps and Sector Weightings.
- SSGA: SSGA is a company that provides many of the popular ETFs such as SPY (the original S&P 500 Spyders), and other sector ETFs.
- BLDRs: BLDRs are registered as unit investment trusts (UITs) and are based on The Bank of New York ADR IndexSM, a real-time index tracking U.S. traded depositary receipts.
- HOLDRs by Merrill Lynch: Sector Based ETF such as a Biotech Holder. You can only buy HOLDRs in round 100 share lots.
Other ETF Resources