ETF NEWS: BACK TO BASICS

Last week I got a question from an Alert reader that asked quite simply, “What is an ETF?”

Now while this question may seem rudimentary to some of you, I took it as a reminder that I have to make sure that whenever I talk about investing tools of any kind, or present investing concepts, that I don’t assume everyone is completely familiar with all the terminology involved. So this week I just want to get back to the very basics by defining what, precisely, an ETF actually is.

The name ETF is short for exchange-traded fund. The simplest definition I’ve seen is that it is an index fund which is traded on the stock market. Now this definition, while succinct, doesn’t do a whole lot to advance your knowledge of what an ETF actually is.

My basic definition is that an ETF consists of a virtual basket of stocks that usually tracks a specific index or sector. To put it another way, ETFs are like a homologous species of mutual funds that allow investors to buy into a specific area of the market without all of the hassles, management fees and trading restrictions imposed by traditional mutual funds.

The first-ever ETF was launched in 1993 on the American Stock Exchange. It was the S&P Depository Receipt, a.k.a. Spiders, SPDR (SPY). SPY offered investors a way to get into the S&P 500 funds without having to buy each individual stock. SPY was new at the time. It was a stock-like instrument that could be bought and sold throughout the day in increments as small as a single share.

It was exciting to be involved with the growth of the U.S. stock market and 500 of America’s largest companies, without having to buy all 500 companies individually.

Today, ETFs have grown into broad indexes and include specialties and niches. We’ve covered many of the developments in the ETF world for the past several years here in the Alert and we plan to keep tracking this area as it continues growing and becoming more of a mainstay in an individual investor’s arsenal.

Hey, it never hurts to get back to basics. I want to thank the reader who sent in that simple, yet all important inquiry about ETFs.

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