UNMASKING COMMON MISBELIEFS REGARDING ETFS
Like stocks, exchange-traded funds (ETFs) are being traded on public exchanges. It also experience price fluctuations throughout a trading day as these funds are being purchased or sold during market hours. Similar to mutual funds, it can neutralize an investment portfolio. But there are some common notions regarding ETFs, to be debunked by this article.
Every index has a corresponding ETF. Unfortunately, that is not the case. Many indexes for securities or economic sectors in less-developed nations and regions have no sector funds upon them. Moreover, ETFs do not always acquire all of the securities within an index or sector, particularly if it is comprised of thousands of various securities like the Wilshire 5000 Index. Funds trailing indexes often only purchase a selection of all the securities inside an index or sector, and use derivatives that can amplify the fund’s returns. Therefore, an ETF can monitor the return of an index or benchmark closely in an economical manner.
ETFs only trail indices. ETFs do not only track indexes, but also sectors, including healthcare and technology, commodities like precious metals and real estate, and currencies. However, there are some ETFs that do not cover few types of assets or sectors.
Leverage is a good thing. Various ETFs can use leverage of differing degrees to attain the desired returns, either directly or indirectly, which are proportionately higher than its underlying index, sector, or group of securities upon which they are linked. Most funds are normally leveraged by a factor of up to three, which can enlarge the profits by the underlying vehicles and render huge, quick profits for investors. Like an old maxim "It takes two to tango," leverage works both ways. So to investors who made a wrong bet, they can sustain large losses in a hurry.
In certain cases, the expense of maintaining leveraged positions in such funds are somewhat substantial. Portfolio managers need to buy positions when prices are high, and sell when they are low to rebalance their holdings that can basically erode the returns recorded by the fund in a somewhat short time period. But several leveraged funds simply do not post returns in tune with their leverage proportion over time periods greater than one day due to the result of compounding returns that mathematically disrupts the fund’s capacity to monitor its index or benchmark.
ETFs levy lesser fees than mutual funds. Normally, ETFs may be bought and sold for the similar type of commission placed for trading stocks or other securities. On that note, it can be way cheaper to obtain than open-ended mutual funds, as long as a huge amount is being traded. But ETFs won’t be a good option for small periodic investments like a $100 a month dollar-cost averaging program in which the same commission has to be paid for every purchase. Frequently, ETFs have no breakpoint sales like traditional load funds.
ETFs are passively managed. Even though majority of ETFs still look like UITs, ETFs are composed of more than Spiders (SPDR), Diamonds, and Cubes. Actively managed funds have established an image in recent years and can possibly continue to attract appeal in the future.
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