Investing in ETFs has become both extremely popular and easy. Many of the pitfalls or challenges of investing in mutual funds do not apply to ETFs and this has led many former fund investors into ETFs.
As I mentioned in a previous article, ETFs (Exchange Traded Funds) are similar to mutual funds because an ETF represents investments in a number of stocks. For example:
• IYE – iShares Dow Energy holds various energy stocks
• EWZ – iShares Brazil holds various Brazilian stocks
• SHY – iShares 1-3 Yr Treasury Bonds holds various 1-3 year bonds
There are many hundreds of ETFs available with new ones being created by different companies on a regular basis. As with mutual funds you can create groups (or universes) of ETFs from which to choose your investment positions, including:
• Domestic
• Foreign
• Emerging Markets
• Sectors
• Assets
• Health
• Commodities
Because ETFs trade like stocks you can buy or sell at any time without any restrictions. This is one of the biggest differences between ETFs and mutual funds. Some brokers have responded to the movement to trade ETFS by allowing you to trade some ETFs with no trading fees.
One of the other differences between ETFs and mutual funds is that ETFs are not actively managed, meaning the ETF owner, like iShares, puts together the group, but doesn’t trade stocks in and out to find the best current holdings.
Like anything else, there are a few potential pitfalls in trading ETFs. Because many are new or cover a small niche area of the market their trading volume may be quite low. This means you may not be able to sell when you want to sell if you pick one of these new or small niche ETFs. It also means that the new niche ETFs may not even stay around; many have died and disappeared in the last few years simply because of lack of interest.
Simple screening on the internet or using software that can show you volume or provides you with groups of proven ETFs will help you avoid these pitfalls.
Trading strategies with ETFs can be similar to trading stocks. You can go in and out as often as you desire. You can trade daily, weekly or however infrequently you desire by developing strategies based on your preferences. I usually have multiple strategies for the same group, “sectors” for example, based on semi-frequent trading (no more than once a week) and infrequent trading (no more than once a month).
Personally I find it easier to trade ETFs because I don’t have to think about the various mutual fund trading factors while at the same time I have a degree of diversification instead of putting all my eggs in one basket as when you buy a particular stock.