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What is an ETF?

By  +Follow January 21, 2014 9:00AM
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It’s an age-old maxim that is as true today as it ever was: the majority of mutual fund managers fail to beat the market. More specifically, a mid-2012 survey by Standard & Poor’s found that 65 percent of fund managers trading large, blue-chip stocks failed to beat the S&P 500. In fact, the S&P Composite 1500 beat 89.4 percent of mutual funds over the year preceding the study. Oof.

But is that fair to the fund managers? Annualized returns for the S&P 500 are right around 10 percent on average, a rate almost any investor would have to be pretty happy with. Since its inception, the lowest average annual return for the index over any one 25-year period is 9.28 percent. Again, the lowest. The best annualized return over any 25-year period was 17.25 percent, and the median was 12.98 percent.

Whether or not this qualifies as an indictment of stock-picking as a whole remains up for debate, but anyone looking at the above numbers might come to a rational conclusion: why keep paying fund managers so they can try and fail to beat these benchmarks? What if you could just buy shares in the S&P 500 itself? Wouldn’t you rather just do that?

And the answer to that question came in the form of the Exchange-Traded Funds (ETF) designed to match the performance of an index, thus circumventing the question of outperforming “the market” altogether. Because, after all, if you can’t beat ‘em, join ‘em.

What Are ETFs?

Simply put, an ETF is a portfolio of stocks (or other assets, but more on that later) that are managed by a financial company, or issuer. That company then sells shares of the portfolio to the general public. Which is almost exactly what a mutual fund is.

The key difference in an ETF is that the company managing the portfolio, rather than attempting to maximize returns by selecting those stocks the managers like the most, is trying to replicate the movement of a specified target index. This is notable because it’s actually remarkably easy to do, unlike hand-picking a portfolio that beats the market.

So, for the SPDR S&P 500 ETF ($SPY), by far the most-traded ETF, the goal is to match the movement of the S&P 500. The managers carefully maintain a portfolio that has the same proportions of those 500 stocks as the index, and the results are a fund that tracks the S&P 500 to within tenths of a percentage point.

The same is true for the SPDR Dow Jones Industrial Average ETF ($DIA) and the, you guessed it, Dow Jones Industrial Average. And the Nasdaq Composite Index Tracking Stock (ONEQ) and the Nasdaq Composite. And, at this point, pretty much any other index you can think of and the ETF someone maintains to track it.

Does It Work?

And how do they usually do? Well, given the difference in scale, it’s virtually impossible to perfectly replicate returns, but the people designing ETFs have it down to enough of a science that they come darn close.

From early 2004 to early 2014, the S&P 500 rose 64.76 percent while the SPY gained 64.03 percent. And, from early 1994 to 2014, 20 years that span nearly the entire life of SPY, the index has returned 296.26 percent to the fund’s 294.23 percent. While not perfect, few investors are willing to quibble over those fractions of a percent each year.

The ETF Industry

ETFs have exploded in popularity since their introduction, with over 1,200 different products controlling more than $1 trillion in assets. With so many different options, one can make any number of very broad or very specific bets on a variety of different market conditions using ETFs. There are commodity ETFs to track commodity prices, bond ETFs that track the returns of baskets of bonds, and ETFs focused on very specific industries, like the Robo-Stox Global Robotics & Automation Index ETF ($ROBO), which specifically follows robotics stocks.

The industry for ETF issuers, those companies that take responsibility for creating and maintaining the funds, has also taken off and includes most of the traditional actors in the finance world. However, the most prominent issuer is probably State Street Corporation (STT) , which issues the ever-popular SPDR funds that cover most of the S&P’s sector-specific indices among others. Other major issuers include iShares (a subsidiary of BlackRock (BLK), Guggenheim Funds, Global X Funds, and the Vanguard Group.

Most Popular ETFs

The ETFs that trade the most shares on an average day illustrate the range of uses investors and traders alike have found for the instruments.

Certainly, many of the top 10 most-traded funds represent those offering a chance to make broad, relatively low-risk bets on large indices, like the SPY, the SPDR Financial Select Sector SPDR ($XLF), the iShares Russell 2000 Index ETF ($IWM), which tracks the Russell 2000 Index, and the PowerShares QQQ ($QQQ), which tracks the Nasdaq-100 Index.

However, some of the other high-volume ETFs represent a much more speculative, high-risk approach. The iShares MSCI Emerging Markets Index ETF (EEM) represents an investment in foreign, emerging market equities most would usually avoid in a risk-off environment, and the Market Vectors Gold Miners ETF ($GDX) is made up of gold mining stocks that tend to display wide moves in value in relation to the price of gold. And the iPath S&P 500 VIX Short-Term Futures ETN (VXX) tracks the volatile and little-understood VIX index.

ETFs: A Part of Most Balanced Portfolios

Ultimately, ETFs are a valuable investment and trading vehicle that are flexible and useful. Virtually any investor could most likely compliment their portfolio by understanding and utilizing them, provided that one’s familiar with what they are and how they best fit into a broader investment strategy.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions.


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Results for SPY
Nina
25 Oct 14 05:29:45
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Rodney
25 Oct 14 05:28:48
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
AL
25 Oct 14 05:27:34
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Junior League Tucson
25 Oct 14 05:27:02
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Mr. Dolla Maker
25 Oct 14 05:27:01
Chart Tells Me $SPY Is Going To Touch $198 Next Week. Not That Much Room To Grow After The Amazing Comeback We Had Last Week.
Mr. Dolla Maker
25 Oct 14 05:26:58
@kenr0966 Yea, Chart Tells Me $SPY Is Going To Touch $198 Next Week. Not That Much Room To Grow After The Amazing Comeback We Had Last Week.
Abram Brown
25 Oct 14 05:26:27
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Abram Brown
25 Oct 14 05:26:01
RT @philstockworld: Friday Freak-Out: #Ebola Spooks the Markets, Iron Ore Collapsing -- http://t.co/l9C4m3vxVZ $SPY $DIA $IWM $QQQ #Futur…
Tyler
25 Oct 14 05:25:37
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
LEADRS
25 Oct 14 05:25:11
w7sreymikc: RT lancejepsen: $SPY VS $IWM Would have liked to see more leadership from IWM throughout the day but... http://t.co/2eQ4delWIt
Esmond Craig
25 Oct 14 05:24:13
RT @lancejepsen: GST Stock Trader News $SPY $IWM $QQQ http://t.co/tcS9pPPnZN
Maximo Martin
25 Oct 14 05:24:13
RT @lancejepsen: $SPY VS $IWM Would have liked to see more leadership from IWM throughout the day but what a surge into the close! http://t…
Convergence Gaming
25 Oct 14 05:23:54
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Port of Coos Bay
25 Oct 14 05:23:37
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Port of Coos Bay
25 Oct 14 05:23:23
RT @philstockworld: Friday Freak-Out: #Ebola Spooks the Markets, Iron Ore Collapsing -- http://t.co/l9C4m3vxVZ $SPY $DIA $IWM $QQQ #Futur…
Convergence Gaming
25 Oct 14 05:23:23
RT @philstockworld: Friday Freak-Out: #Ebola Spooks the Markets, Iron Ore Collapsing -- http://t.co/l9C4m3vxVZ $SPY $DIA $IWM $QQQ #Futur…
Kathy Seabrook
25 Oct 14 05:21:59
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
40 million boy
25 Oct 14 05:21:40
The MACD looking awesome RT “@WallStJesus: CALDARO: weekend update .. http://t.co/MST6ckIqxw $SPX $SPY http://t.co/bBBnGN5G0n”
Kathy Seabrook
25 Oct 14 05:21:30
RT @philstockworld: Friday Freak-Out: #Ebola Spooks the Markets, Iron Ore Collapsing -- http://t.co/l9C4m3vxVZ $SPY $DIA $IWM $QQQ #Futur…
Hampton Inn Valdosta
25 Oct 14 05:20:58
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Hampton Inn Valdosta
25 Oct 14 05:20:18
RT @philstockworld: Friday Freak-Out: #Ebola Spooks the Markets, Iron Ore Collapsing -- http://t.co/l9C4m3vxVZ $SPY $DIA $IWM $QQQ #Futur…
Eric
25 Oct 14 05:20:11
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
WizardOfTheOS
25 Oct 14 05:19:51
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
JE$US
25 Oct 14 05:19:39
CALDARO: weekend update .. http://t.co/Rq370FhEnW $SPX $SPY http://t.co/XE2VSVZYno
Eric
25 Oct 14 05:19:33
RT @philstockworld: Friday Freak-Out: #Ebola Spooks the Markets, Iron Ore Collapsing -- http://t.co/l9C4m3vxVZ $SPY $DIA $IWM $QQQ #Futur…
RICK
25 Oct 14 05:19:14
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
kenr0966
25 Oct 14 05:18:32
RT @MoneyShows: $SPY $QQQ $IWM $DIA $IYT The Week Ahead: This Market Could Hurt Stocks http://t.co/0Ac6QVQlI9
Craig Davis
25 Oct 14 05:17:15
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Angela
25 Oct 14 05:16:47
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
JEREMY C THUKU
25 Oct 14 05:16:09
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Artis • design
25 Oct 14 05:16:03
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Artis • design
25 Oct 14 05:15:43
RT @philstockworld: Friday Freak-Out: #Ebola Spooks the Markets, Iron Ore Collapsing -- http://t.co/l9C4m3vxVZ $SPY $DIA $IWM $QQQ #Futur…
Sandra
25 Oct 14 05:14:35
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Transparency USA
25 Oct 14 05:11:03
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Roger Pereira
25 Oct 14 05:10:57
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Ms.
25 Oct 14 05:09:47
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Todd
25 Oct 14 05:09:02
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
alex demache
25 Oct 14 05:08:29
$spy ppl hated the mkt at 1820.. Thot it was overpriced given the global economy. Now they love it at 1960. What changed? Passing some MAs?
B.
25 Oct 14 05:07:51
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Kraig Reed
25 Oct 14 05:07:13
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Kokab Farshori
25 Oct 14 05:07:06
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Kraig Reed
25 Oct 14 05:06:46
RT @philstockworld: Friday Freak-Out: #Ebola Spooks the Markets, Iron Ore Collapsing -- http://t.co/l9C4m3vxVZ $SPY $DIA $IWM $QQQ #Futur…
Kokab Farshori
25 Oct 14 05:06:43
RT @philstockworld: Friday Freak-Out: #Ebola Spooks the Markets, Iron Ore Collapsing -- http://t.co/l9C4m3vxVZ $SPY $DIA $IWM $QQQ #Futur…
Ramiro Arellano
25 Oct 14 05:06:21
RT @StockTwits: On this day, 85 years ago, the biggest crash in stock market history happened http://t.co/ZJipj9IOEl $SPY http://t.co/Yl71j…
Timothy Reazor
25 Oct 14 05:06:02
Come on fellow #StockNerds wake up! You have a video to watch :) http://t.co/zJJBEK8oht $SPY $QQQ &AAPL $NFLX $GLD $IWM
Casting Director
25 Oct 14 05:05:56
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
alex demache
25 Oct 14 05:05:46
@DougKass Whn $spy was at 182 most tweeters saying going back to 200 will b hard. Now all tweets r saying $spy going to 210 #bs #euphoria
Casting Director
25 Oct 14 05:05:20
RT @philstockworld: Friday Freak-Out: #Ebola Spooks the Markets, Iron Ore Collapsing -- http://t.co/l9C4m3vxVZ $SPY $DIA $IWM $QQQ #Futur…
Tom Compeau
25 Oct 14 05:04:58
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
Keith espinosa
25 Oct 14 05:04:06
RT @philstockworld: Friday's Fearful Outlook as #Ebola Hits NYC: $SPY $DIA $AMZN $TSLA $TM #Amazon -- http://t.co/UIMDFJvSW2 http://t.co/VN…
				
				
By  +Follow January 21, 2014 9:00AM
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