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ETFs – All about Index Shares

SPDRs, DIAMONDS , QQQQ or WEBS. Whatever you want to call them, they are grabbing an increasing share of interest and resources from sophisticated investors. The first index shares created by Amex were SPDRs, or Standard & Poor’s Depository Receipts.

Separate SPDRs were created for the S&P 500 and the S&P Mid-Cap 400. Trading in S&P 500 SPDRs was introduced in 1993, and the S&P Mid-Cap 400 began in 1995. Seventeen World Equity Benchmark Shares (WEBS) began trading a fixed basket of country securities in 1996. DIAMONDS, an index product based on the Dow Jones Industrial Average, began trading in early 1998.

Once created, the depository receipts trade just like common shares of stock. They can be traded in round or odd lots, and trade between the hours of 9:30 a.m. and 4:15 p.m. They pay dividends, but unlike stocks, can be shorted on downticks, which enhances liquidity.

The annual expenses on SPDRs are lower than expenses on most mutual funds, and the index shares are more tax-efficient. They appeal to short sellers because they can be shorted in falling markets when downticks occur, which can’t be done with individual stocks. They are highly liquid, and can be traded intra-day when sharp movements can occur, rather than only at the end-of-the-day price provided for mutual funds.

ETFs (also called index shares) track a specific basket of securities and trade continuously on the major exchanges like an ordinary stock. The pioneering big daddy of ETFs was the Standard & Poor’s Depositary Receipts (AMEX: SPY) — also known as SPDRs, pronounced “Spiders” — which appeared in 1993. These were followed by the Dow Diamonds (AMEX: DIA), a basket of the 30 Dow stocks, and the Nasdaq 100 Shares (AMEX: QQQQ) — a.k.a. Qubes — which track the Nasdaq 100 stock index. Even though they’ve only been around since March 1999, Qubes are so popular, their daily trading volume rivals the companies on the New York Stock Exchange. (Today, only three companies on the Big Board traded more briskly.)

Another advantage is that ETFs can be shorted and bought on margin. We don’t think that borrowing money to buy stocks is a smart way to invest, although in limited amounts by experienced investors it can be useful.

Perhaps the greatest benefit of ETFs is that they bring investors instant exposure to a diversified portfolio of stocks.

For many investors with a long-term vision who can embrace the benefits of ETFs without falling into the trading traps that accompany it, investing through ETFs can be quite rewarding to the pocketbook, and a superior alternative to mutual funds.

By trading the index, you eliminate concerns about picking the right company, balancing industry weightings, or incurring the cost of trading individual stocks. Best of all, you eliminate the traditional bias to the upside, so you can profit from both bull as well as bear markets.

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