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Exchange Traded Funds – The Inside Information

Say goodbye to mutual funds and hello to exchange traded funds! Many investors are now spurning mutual funds for exchange traded funds. Exchange traded funds are the investment darlings of both retail investors and ordinary investors. These low cost investments are easy to buy and are cheaper to purchase than mutual funds.

Let’s take a look at the pros and cons of ETF investing.

  • Advantages of ETF’s

Exchange traded funds are hybrid investments. They have many of the features of a mutual fund and a stock. An ETF is just like a mutual fund except that exchange traded funds are traded on stock exchanges.

An ETF is like a mutual fund in that it provides more diversification than investing in a single stock will. An ETF is like a stock in that its prices change throughout the day and that it can be sold anytime during market hours.

ETF’s can make index and sector investing a snap. ETF funds are cheaper than even passive mutual funds like index funds. ETF investing is do-it-yourself investing. You avoid the fees of active fund management and get the same benefits of a diversified portfolio. It’s also a great way to invest in a sector without having to guess them right stocks.

For example, let’s say you are bullish on the biotechnology sector. It can be virtually impossible to guess which companies will be the winners and losers in the sector. The easiest thing to do is to buy a biotechnology ETF which will let you benefit from the advances of any particular stock.

  • Dangers of ETF’s

Very few sites warn you about the dangers of exchange traded funds. Since the prices of ETF’s change during the day, many investors are tempted to try and trade ETF’s. They try to use market timing to enter and exit an ETF quickly. More often than not ETF investors find themselves getting burned employing this strategy. Market timing has also led to the rise of leveraged ETF’s.

Leverage ETF’s use debt to generate returns two to three times a normal ETF’s. While these ETF’s can quickly make you money; they can also destroy your wealth in a matter of days. Many investors mistakenly hold onto these levered ETF’s as if they are investments. Levered ETF’s are not investments and should not be treated as such. They are only appropriate for short term trading and have to be watched very closely.

A perfect example of this can be seen by looking at the ProShares UltraShort Real Estate Fund (SRS). It sounds like a great investment. The real estate market has been in the doldrums so this ETF has to be up huge. Think again! If you bought this fund then you would have lost almost all of your money. This fund is down 94% over the past 2 years alone.

Final Thoughts

Hopefully you now have a better understanding of the good and bad of ETF’s. Remember to always do your homework before selecting an ETF. ETF’s can help you build wealth and increase your investing returns when properly used. Used improperly, they can quickly eat up your money and turn into your worst nightmare.