Investing Made Easy: Exchange Traded Funds!

By Mark Reiter, MD, MBA, University of North Carolina

Exchange traded funds (ETFs) offer an excellent opportunity for both novice and experienced investors to earn a rate of return similar to the overall stock market with minimal effort and know-how. ETFs are aggregates of the major stock market indexes, but can be bought and sold like any stock. The three most popular ETFs are SPYDERS (ticker: SPY), that mirrors the S&P 500 (the 500 largest U.S. companies), DIAMONDS (ticker: DIA), that mirrors the Dow Jones Industrial Average (30 large U.S. companies), and CUBES (ticker: QQQ), that mirrors the Nasdaq 100 (the 100 largest companies on the Nasdaq exchange, mainly technology companies).

Generally, the S&P 500 (SPY) is the least volatile of the three and is the standard to which most stocks and mutual funds are compared. The 11% historical rate of return of the stock market refers to the S&P 500. DIA and QQQ are generally more volatile than SPY, and typically offer better returns than SPY in a good year and worse returns in a bad year. DIA and QQQ are more volatile because they are an aggregate of fewer stocks (30 and 100 versus 500) and because the companies within each index are not as diversified as SPY. There are dozens of other less well-known ETFs available, but many of them are sector/industry-specific and will subsequently be much more volatile because they are not as well diversified.

So, even if you know nothing at all about the stock market, you should be able to earn a solid rate of return by simply buying shares of an ETF and holding for years or decades. You do not need to keep track of any developments or know anything about investment analysis, just buy the shares, and put your portfolio on autopilot. Buying an ETF like SPY, offers the advantages of a diversified portfolio (low volatility) with the ease of buying only one stock (that mirrors the performance of 500).

Published in the December 2004/January 2005 EM Resident.

 

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