What Are Exchange Traded Funds

A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. ETFs experience price changes throughout the day as they are bought and sold.

Because it trades like a stock, an ETF does not have its net asset value (NAV) calculated every day like a mutual fund does.

By owning an ETF, you get the diversification of an index fund as well as the ability to sell short, buy on margin and purchase as little as one share. Another advantage is that the expense ratios for most ETFs are lower than those of the average mutual fund. When buying and selling ETFs, you have to pay the same commission to your broker that you'd pay on any regular order.

One of the most widely known ETFs is called the Spider (SPDR), which tracks the S&P 500

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Exchange-traded funds (ETFs) can be a valuable component for any investor's portfolio, from the most sophisticated institutional money managers to a novice investor who is just getting started. Some investors use ETFs as the sole focus of their portfolios, and are able to build a well-diversified portfolio with just a few ETFs. Others use ETFs to complement their existing portfolios, and rely on ETFs to implement sophisticated investment strategies. But, as with any other investment vehicle, in order to truly benefit from ETFs, investors have to understand and use them appropriately.

Understanding most ETFs is very straightforward. An ETF trades like a stock on a stock exchange and looks like a mutual fund. Its performance tracks an underlying index, which the ETF is designed to replicate. The difference in structure between ETFs and mutual funds explains part of different investing characteristics. The other differences are explained by the type of management style. Because ETFs are designed to track an index, they are considered passively managed; most mutual funds are considered actively managed. (For more insight, read Mutual Fund Or ETF: Which Is Right For You? and Active Vs. Passive Investing In ETFs.)

From an investor's perspective, an investment in an index mutual fund and an ETF that tracks the same index would be equivalent investments. For example, the performance of the SPDR S&P 500 ETF and a low-cost index fund based on the S&P 500 would both be very close to the to the S&P 500 index in terms of performance.

Although index mutual funds are available to cover most of the major indexes, ETFs cover a broader range of indexes, providing more investing options to the ETF investor than the index mutual fund investor.

Low Risk Investing Strategies

In the past couple years, many of us have taken some pretty big hits in our investment portfolios even in markets that we were told were "safe" or "recession proof."

I don't know about you, but I would like to get nice returns even if the market goes down. Heck, I'd settle for my portfolio staying not losing value and just staying the same during an economic downturn.

And that's what I'm going to talk about today. Some low risk investing strategies to do just that.

Understanding Risk

First, let's start off with an example of risk and why it isn't wise to risk a large percentage of your portfolio on a single trade.

There are some systems out there that have you risking 5% or even 10% of your money on a single trade. And while that's not too hard to make back, the problem occurs when you have a few bad trades in a row.

And if somebody tells you their system never has a losing trade, they're lying. Even the best will have a few losers in a row from time to time.

So let's say you have a few bad trades and your $50,000 account goes to $30,000. That's a 40% loss. Ouch.

So what return do you need to get to make back that 40% loss? Hint: It isn't 40%. It's actually 66.6% that you need to get now. I'll spare you the math, but you're welcome to do it. The reason that it's so much higher is that when you lose money you have a smaller base to work with than before.

Can you see why nearly all professional money managers are only willing to risk at most 2% on a single trade and frequently it's more like .5% or 1%.

That means even if the trader has 10 consecutive bad trades (it will happen at some point to everyone), you'll still only have lost about 20% of the account which can be made up with a few good trades. However, much beyond that 20%, and you're on dangerously thin ice.

Most people think mutual funds and bonds when they want low risk investing, however, exchange fund trading offers a lot of the same benefits that mutual funds do, but with better liquidity, lower fees, and intraday trading ability.

Thanks to Gary_Ruplinger for the article