Exchange Traded Funds (ETFs) are portfolios similar to mutual funds, but are traded on an exchange like stocks. They combine the diversification, transparency and tax efficiency of mutual funds with the flexibility and liquidity of stocks.
Much like mutual funds, ETFs generally invest in a portfolio of securities that track a specific market, asset class, investment strategy, or index. Most mutual funds, however, typically only allow purchases and redemptions (sales) once per day. Unlike mutual funds, ETFs can be traded throughout the day during regular market hours.
They combine the diversification, transparency and tax efficiency benefits of mutual funds with the flexibility and liquidity of stocks. They provide investors an opportunity to gain exposure to different asset classes and indexes with generally lower expense ratios. The structure provides investors the ability to sell short or long as many or few shares as desired to reach their objectives.
Unlike mutual funds, which often report holdings on a quarterly basis, ETFs publish holdings daily so the investor knows exactly what they own. The underlying holdings are often direct representations of the asset class or index the ETF tracks. The price of an ETF does not rise and fall based only on the trading demand, but also the underlying indicative value of the holdings which are calculated and reported throughout the day.
As an investment structure, ETFs are generally suitable for investors who are seeking a flexible, "single ticket" solution to gain exposure to a specific market, asset class, index, or investment strategy. Keep in mind, not all ETFs are meant for every investor and can vary greatly depending on the investment objective. As with most investments, there are risks involved with ETF investing, including fluctuation of investment value and the possibility for loss. Always read the prospectus before investing.
What is yield?
An investment's total return is typically derived from two sources-capital appreciation and yield. The capital appreciation portion of return is basically the increase of market value. The yield, however, is the portion of return that comes from interest and earnings. For bonds, yield is tied to directly to the interest rate, whereas a stock's yield comes in the form of dividends from earnings. Beyond stocks and bonds, there are other investments that generate a yield, such as real estate investment trusts (REITs) and master limited partnerships (MLPs) of the oil and gas industry.
Why is yield important?
Investors often rely on the yield from their investments as source of income. Unfortunately, with money markets, bank CDs and savings accounts only paying a fraction of what they used to pay, many are looking for other sources of income. Stocks, bonds and alternative investments all have the potential to provide sources of income outside of traditional savings-based accounts. But for some investors, income is not the primary reason for seeking yield. Some investors use yield as a portfolio diversifier to offset other capital investments. In either case, generating the highest yield possible while also giving consideration to investment risk is a balance that many investors strive to achieve.
With interest rates near historic lows, achieving a competitive yield can be challenging in today's market. Investors are seeking alternate sources of yield, both domestically and overseas. Unfortunately, accessing yield-centric investments on a global scale can be very labor intensive-often reserved for institutional investors only. Many yield-based investments are simply out of reach for the typical investor as the minimum capital requirements to create a diversified portfolio can be quite high. Fortunately, professionally managed globally diversified yield portfolios are now within reach through the liquidity, transparency and affordability of ETFs.