Only Exchange-Traded Funds (“ETFs”) that are open-end investment companies or unit investment trusts under the Investment Company Act of 1940 (“1940 Act”) are covered here. Exchange-traded commodity funds and exchange-traded notes are not covered because they are not ETPs required to be registered under the 1940 Act.
This article is a broad scope and will not be tailored to your own financial needs. Make sure you have a firm grasp on the specifics of the investment product you’re contemplating before putting money into it.
Defining Exchange-Traded Funds
All exchange-traded funds (ETFs) are required by the 1940 Act to register with the SEC as either an open-end investment company (often referred to as “funds”) or a unit investment trust.
Similar to mutual funds, exchange-traded funds (ETFs) allow investors to pool their money in a fund that invests in stocks, bonds, or other assets, and in return, each participant receives a portion of the fund’s investment returns. When compared to mutual funds, exchange-traded funds (ETFs) trade on a national stock exchange at market prices that may or may not correspond to the Net Asset Value (NAV) of the shares, which is the value of the ETF’s assets minus its liabilities divided by the number of existing shares.
Tips for Buying Exchange-Traded Funds
Exchange-traded funds (ETFs) are different from mutual funds. In general, ETFs combine the liquidity of a mutual fund (shares can be bought and sold at the end of the trading day at the fund’s NAV) with the liquidity of a closed-end fund (shares move throughout the trading day at market prices).
The only way for individual investors to buy or sell shares of an exchange-traded fund is through a market transaction, which is not the case with mutual fund shares. This means that, unlike mutual funds, retail investors cannot buy or sell shares of ETFs directly from the company. In its place, ETF issuers form contractual partnerships with one or more financial institutions referred to as “Authorized Participants.” The majority of Authorized Participants are huge broker-dealers. Only Authorized Participants may buy or redeem shares directly from the ETF, and they may only do so in large blocks (e.g., 50,000 ETF shares) that are referred to as “Creation Units.”
ETF shares are traded on the open market, where other investors buy and sell them at market prices. The NAV per share of an ETF may be greater than or less than its market price. This is due to the fact that the NAV of an exchange traded fund (ETF) is the value of an ETF’s assets minus its liabilities as calculated by the ETF at the end of each business day, while the market price of an ETF fluctuates throughout the trading day due to various factors such as the underlying prices of the ETF’s assets and demand for the ETF.
Types of ETFs
Index-Based ETFs
Today, index-based ETFs make up the vast majority of the market. These ETFs, like the S&P 500 stock index, aim to replicate the performance of a securities index by purchasing a broad portfolio of securities that make up that index. The SPDR, or “spider,” ETF, for instance, invests in the vast majority (if not all) of the equities instruments that make up the S&P 500 stock index in order to replicate its performance. Unlike mutual funds, exchange-traded funds (ETFs) may or may not update their holdings daily on their respective websites.
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Actively Managed ETFs
Actively managed ETFs are not index-tracking investments. Instead, they invest in a variety of securities in order to reach their goal. An actively managed ETF’s portfolio components may be bought or sold on a daily basis without regard to the index against which it is benchmarked.
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In Conclusion
Both the summary prospectus and the full prospectus of an exchange-traded fund (ETF) should be read in full before making any investment decisions related to that ETF. These documents contain important information about the ETF’s investment objective, principal investment strategies, risks, costs, and historical performance (if any).
You can find a specific ETF prospectus using the SEC’s EDGAR system or through an online search engine.
You can also find a prospectus for an ETF from your broker or the financial institution that underwrites it.
Do not put money into something you do not fully grasp. An investment opportunity may not be worth pursuing if it requires more explanation than can be given in a few simple sentences.
Last but not least, it’s always a good idea to consult an expert while making financial decisions.
When doing so, consult with a professional who is familiar with your specific investing aims and comfort level.
If you’re working with an investing professional, they should be able to explain complex technicalities and how they may or may not meet your goals.
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