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Terms Of The Trade: Exchange-Traded Funds And Exchange-Traded Notes

Terms Of The Trade: Exchange-Traded Funds And Exchange-Traded Notes

The popularity of ETFs and ETNs has exploded in recent decades, but some investors may not even know exactly what they are, what they offer investors and how they differ.

An exchange-traded fund is a fund that owns underlying assets and divides up ownership of those assets into shares. Those shares are then traded on a stock exchange like shares of stock, which makes ETFs different than mutual funds.

ETFs can track entire stock market indices, such as the SPDR S&P 500 ETF Trust (NYSE: SPY), which tracks the S&P 500. They can also track a single market sector, such as the Energy Select Sector SPDR (ETF) (NYSE: XLE), which tracks the energy sector. Certain ETFs even track other types of assets. The SPDR Gold Trust (ETF) (NYSE: GLD) tracks the price of gold, and the iShares Barclays 20+ Ty Treas.Bond (ETF) (NYSE: TLT) tracks the performance of U.S. Treasury bonds with remaining maturities greater than 20 years.

The primary advantage ETFs offer is the ability to instantly diversify without the trading fees associated with buying all of the fund’s underlying assets. However, the biggest disadvantage to ETFs is that they charge management fees, which are measured by a number called the expense ratio. Expense ratios are typically less than 1.0 percent annually, but they vary from fund-to-fund.

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An exchange-traded note is an unsecured debt note that is structured more like a bond than a stock. ETNs can be bought or sold at any time or held until they mature. The iPath Bloomberg Commodity Index Total Return ETN (NYSE: DJP) tracks the performance of a diversified basket of commodities, including WTI crude oil and copper. As the name implies, the Barclays Bank Plc iPath ETNs linked to the MSCI India Total Return Index (NYSE: INP) tracks an index of 60 companies listed on the National Stock Exchange of India.

While ETNs offer the same kind of instant diversification that ETFs do, they also come with risks. ETNs are subject to the health and credit ratings of their underwriters, which are typically banks.

For investors who understand the risks and fees involved in ETFs and ETNs, the two investment products offer a number of advantages and opportunities that have never before been available to the average investor.

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Disclosure: the author holds no position in the stocks mentioned.


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