A relative new comer to the investment world is the Exchange Traded Fund (ETF). You can think of it as a cross between individual stocks and mutual funds, with a mixture of advantages and disadvantages of each. An ETF trades on a stock exchange like a stock but the underlying investment holds stocks and bonds similar to a mutual fund. Like stocks, when you buy and sell an ETF you generally pay a commission. Since the underlying securities are not being traded there are potential tax efficiencies from avoiding capital gain distributions and minimizing management fees.
Before 2008 when the U.S. Securities and Exchange Commission authorized the creation of actively-managed ETFs, all U.S. ETFs tracked an index. It is not surprising that the older ETFs track the most popular indexes such as:
- S&P 500 Depositary Receipt (SPY) tracks the S&P 500 Index
- Vanguard Total Stock Market ETF (VTI) tracked Dow Jones Wilshire 5000 Composite Index through April 22, 2005, and performance of the MSCI US Broad Market Index thereafter.
Given the efficiencies of ETFs there has been a great deal of interest in them. Despite 2008′s market crash, there were 160 new exchange-traded funds launched with net inflows into U.S. equity exchange-traded funds of $120.8 billion. ETFs are gaining market share at the expense of mutual funds. In 2008, there were only 21 new mutual funds and U.S. equity mutual funds saw a $162.4 billion net outflow. Many mutual fund companies have seen the writing on the wall and have decided that if you can’t beat them, join them.
At the time of this writing, Vanguard offerd 38 ETFs covering just about every conceivable sector and niche. Here are several random samples:
- Long-Term Bond ETF (BLV) tracks Lehman Brothers Mutual Fund Long Government/Corporate Index
- Dividend Appreciation ETF (VIG) tracks the Dividend Achievers Select Index
- REIT ETF (VNQ) tracks Morgan Stanley REIT Index
- FTSE All World ex US (VEU) tracks the FTSE/(R)/ All-World ex USA Index
ETFs can be used to fill a void where you either don’t have the expertise or the time needed to pick individual stocks, such as international dividend investing. Like any other index, an ETF will likely hold securities that you would not buy otherwise.
Full Disclosure: Long VTI, BLV, VIG, VNQ