Are you a 'Trader' or an 'Investor'? Why does it matter and what does it have to do with ETF's?
First, an ETF, also called Exchange Traded Funds, is very similar to a mutual fund. Like a mutual fund, it holds a 'basket' of different securities, bonds, derivates, etc., depending on what the assest class the fund has been set up for. The symbol SPY is an ETF that tracks the S&P 500 index. Therefore, the ETF at least in theory holds the same stocks that makes up part of the S&P 500. However, unlike a mutual fund, an ETF can be traded just like stocks and can be purchased through a simple brokerage account anytime the market is open. Whereas a mutual fund is generally purchased directly from the mutual fund company (although with some brokerages, you can also buy mutual fund through them instead of the mutual fund company) and are purchased based on the NAV or net assest value.
One major problem with the NAV is that it is based on the closing price of all the assets in the mutual fund. In other words, if there is a large fluctation in the S&P throughout the day, where the opening value say of the S&P was lower but some catalyst mid-day caused it to go higher towards the end of the day, you are stuck buying the mutual fund at the higher closing price. Who wants to buy high?
Another problem has to do with when the mutual fund can be purchased. In other words, unless you have cash parked with the mutual fund or you are transferring from one fund to another, you would have to send them a check or perform a bank transfer (or you have automatic monthly, weekly, deductions from your bank account).
Another point, look at the S&P and SPY prices in March when the market was in free fall earlier in the month with the lowest on Mar 9.
S&P Index
Date High Low Close
3/30/2009 809.07 779.81 787.53
3/27/2009 828.68 813.43 815.94
3/26/2009 832.98 814.06 832.86
3/25/2009 826.78 791.37 813.88
3/24/2009 823.65 805.48 806.12
3/23/2009 823.37 772.31 822.92
3/20/2009 788.91 766.2 768.54
3/19/2009 803.24 781.82 784.04
3/18/2009 803.04 765.64 794.35
3/17/2009 778.12 749.93 778.12
3/16/2009 774.53 753.37 753.89
3/13/2009 758.29 742.46 756.55
3/12/2009 752.63 714.76 750.74
3/11/2009 731.92 713.85 721.36
3/10/2009 719.6 679.28 719.6
3/9/2009 695.27 672.88 676.53
3/6/2009 699.09 666.79 683.38
3/5/2009 708.27 677.93 682.55
3/4/2009 724.12 698.6 712.87
3/3/2009 711.67 692.3 696.33
SPY ETF
Date High Low Close
3/30/2009 79.87 77.96 78.79
3/27/2009 82.53 81.31 81.61
3/26/2009 83.3 81.32 83.11
3/25/2009 82.7 79.06 81.45
3/24/2009 82.36 80.51 80.6
3/23/2009 82.29 78.31 82.22
3/20/2009 78.91 76.53 76.71
3/19/2009 81 78.69 78.94
3/18/2009 80.9 77.07 79.93
3/17/2009 78.36 75.45 78.18
3/16/2009 77.97 75.81 75.86
3/13/2009 76.98 74.73 76.09
3/12/2009 75.75 71.97 75.5
3/11/2009 73.75 71.83 72.64
3/10/2009 72.37 69.37 72.17
3/9/2009 70 67.73 68.11
3/6/2009 70.45 67.1 68.92
3/5/2009 71.73 68.17 68.8
3/4/2009 72.87 70.07 71.73
As you can see, if you decided to buy an index fund on 3/9 and sent in your check, you would have missed the bottom and by the time the fund was purchased (5-7 days later give or take) missed the bull rally. Whereas if you had purchased the ETF on 3/9 believing it couldnt get any worse, you would have gotten into the rally.
Most of us are unlikely to have the cash to afford all the names in the energy sector like XOM (Exxon), RIG (Transocean), COP (Conoco). But by buying an energy ETF, you can theorectially profit from the run up in energy prices without having to own signifcant shares of each.
If you look at VFH (Vanguards Finanacial ETF) 36.8% of its top ten holdings are in BAC, BK, C, GS, JPM, MET, TRV, USB, WFC. It's price as of 6/12 is 25.09 with a dividend of 4.5%. So you get to 'own' Goldman Saks, Chase, and Wells Fargo.
Therefore, by ETF's you can either profit from the short term gains during the sector rotations (trader), or use it in a buy n hold (investor) strategy.
