What Are Exchange Traded Funds?

This article is a brief introduction to explain what Exchange Traded Funds are, how they work, and how you can use them as part of your investment arsenal.

Basically, an Exchange Traded Fund is a collection of shares that will try to replicate the price action of a particular index such as the S&P500 or a market sector such as Energy or Technology.

Exchange Traded Funds were first introduced in 1989 on the Toronto Stock Exchange, and have gained popularity ever since.

The American Exchange lists over 100 Exchange Traded Funds. The first to be listed here was the SPDR in 1993.

OK, that all sounds good, but how does an Exchange Traded Fund differ from a Mutual Fund offered by an investment company that aims to beat that particular index or sector?

Well, the main difference between an Exchange Traded Fund and a Mutual Fund is that the Exchange Traded Fund is traded as an instrument on the exchange.

Some common features of Exchange Traded Funds are:

  • They have an exchange listing and can be traded continually.
  • They are index linked rather than managed. This means that they follow the index more accurately as Managed Funds often try to out perform the index.
  • The value of the particular Exchange Traded Fund is derived from its underlying assets. However their actual price can differ by being traded at a premium or a discount to the underlying assets.

An example of an Exchange Traded Fund is the Technology SPDR (AMEX:XLK). This is a fund that tracks the Technology sector and is traded on the American Exchange.

If you are interested in trading Exchange Traded Funds, it is important to remember that they may differ from exchange to exchange and country to country. Remember to do your research before doing any trading!

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