Tags: ETFs

What Is an ETF? Six Benefits plus Three to Buy Now

By , Contributing Writer, Money Morning •

What is an ETF? The short answer is that it's a security that trades like a stock, has the diversification of a fund, and is tax-friendly.

Now let's look a little closer at what exchange-traded funds have to offer.

what is an ETFAn ETF, or an exchange-traded fund, tracks an index, commodity, bonds, or basket of assets. ETFs trade like equities on a stock exchange. Prices fluctuate throughout the day as shares are bought and sold.

The first ETF debuted in January 1993. That's when the SPDR S&P 500 ETF Trust (NYSE Arca: SPY), "spider" for short, was launched.

Since then, ETFs have experienced a tremendous growth spurt and increased popularity.

The number of ETFs topped 100 in 2001. A decade later, the sum eclipsed 1,000. Over the last decade, the number of ETFs has grown an average of 27% per year.

Today, there are more than 1,600 ETFs. From clean energy to private equity to short-term volatility, there's an ETF for nearly every sector and investment strategy.

Here's what makes ETFs so popular - plus three great ETFs to buy now...

What Is an ETF? Six Key Benefits

Diversification: Like index funds, ETFs provide an efficient way to invest in a specific sector of the stock, bond, or global market. ETFs also allow market participants to invest in an overall market or an individual country, such as the Standard & Poor's 500 Index, Nasdaq Composite, or Germany.

Transparency: Since ETFs track an index, commodity, sector, or country, it's easy to know exactly what's inside an ETF. Mutual funds' holdings, meanwhile, are usually revealed long after an investment and only periodically throughout the year.

More Trading Control: ETFs trade throughout the day on a major exchange. This allows investors to buy, sell, place limit orders, and enter stops on an ETF during a daily trading session. Conversely, mutual funds are traded just once per day at the close.

Tax Advantages: ETFs are tax-friendly. They minimize capital gains by engaging in "like-kind" exchanges of stocks. Thus the fund doesn't need to sell equities to meet redemptions (sales). Such moves are not treated as a taxable event.

No Investment Minimums: A number of mutual funds have minimum initial and subsequent investment requirements - sometimes $2,500 or $5,000. ETFs, meanwhile, can be purchased for as little as one share.

Low Fees: ETFs typically have an internal expense ratio (fee) of between 0.30% and 0.95%. In comparison, mutual funds' expense ratios are handily over 1%. While 1% annually might not sound like much, consider this. A fee that eats up 1% of assets year after year chips away at returns. That 1% fee on a $10,000 investment earning 5% per year will cost an investor $1,487 after 10 years. After 20 years, it will cost $4,622. ETFs also don't charge 12b-1 fees. These are fees paid to companies and individuals through which investors buy fund shares. In short, investors are paying those agents indirectly via charges that reduce their funds' returns.

Now that you know what an ETF is, here are three ETFs to buy now.

3 ETFs to Buy Now

KraneShares CSI China Internet ETF (Nasdaq: KWEB) gives investors a way to profit from China's booming Internet economy. In July 2014, China had 632 million Internet users, according to a McKinsey & Co report. Compare that to only 277 million in the United States. And with only 46% Internet penetration in China, there's plenty of room for growth. By 2025, China is expected to hit $650 billion in annual online sales, up 242% from $190 billion in 2012. KWEB offers a broad play on the entire Chinese e-commerce sector. Holdings include Alibaba Group Holding Ltd. (NYSE: BABA) at 7.8%, in addition to JD.com Inc. (Nasdaq ADR: JD), Tencent Holdings (OTCMKTS ADR: TCEHY), and Baidu Inc. (Nasdaq ADR: BIDU). "The KraneShares fund is the kind of investment folks should look to incrementally add to when they have extra cash or when the price is down - and look to hold for a number of years to maximize profits," said Money Morning Executive Editor Bill Patalon. KWEB is up 18.47% year to date.

PureFunds ISE Cyber Security ETF (NYSE Arca: HACK) allows investors to tap into the growing and lucrative cybersecurity market. High-profile breaches at marquee companies like Target Corp. (NYSE: TGT), Home Depot Inc. (NYSE: HD), and JP Morgan Chase & Co. (NYSE: JPM) have brought fresh attention to cyberattacks. Cybersecurity spending is expected to reach $155.74 billion by 2019, according to market research firm MarketsandMarkets. That's a 63% growth rate. "The money spent on cyber defense represents one of the highest profit potentials of anything I've encountered," Money Morning's Small-Cap Investing Specialist Sid Riggs said. "And the growth numbers spotlight not just one company but an entire sector that will have the wind at its back for the rest of our investing lifetimes." HACK is up 11.59% year to date.

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SPDR Barclays International Corporate Bond ETF (NYSE Arca: IBND) offers both safety and yield in the struggling Eurozone region. IBND holds 475 bonds. Of those, 76% are European. The average weighted coupon is 3.81%, while the average maturity is 5.6 years. Some $24 billion has poured into European investment-grade bonds year to date, according to Bank of America Merrill Lynch. That's up from $13 billion in the same period last year. Inflows could surpass $95 billion this year if the pace continues. That would mark a 30% year-over-year increase. "With the questionable health of the European Union, I expect investors will quickly realize there's an alternative bond sector with better yields, which at least pays positive yields," Money Morning Resource Specialist Peter Krauth said. "I think quality European corporate bonds are the next bond subsector to get bid up as investors chase yields. Right now, you still have a chance to get in."

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