Nov 1 2014, 08:49 PM, updated 6y ago
DEFINITION OF 'EXCHANGE-TRADED FUND - ETF' Source
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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 index and trades under the symbol SPY.
Benefits of ETFs Source
The Benefits of Trading Like a Stock
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The easiest way to highlight the advantage of the ETF trading like a stock is to compare it to the trading of a mutual fund. Mutual funds are priced once per day, at the close of business. Everyone purchasing the fund that day gets the same price, regardless of the time of day their purchase was made.
Because, like traditional stocks and bonds, ETFs can be traded intraday, they provide an opportunity for speculative investors to bet on the direction of shorter-term market movements through the trading of a single security. For example, if the S&P 500 is experiencing a steep rise in price through the day, investors can try to take advantage of this rise by purchasing an ETF that mirrors the index (such as a SPDR), hold it for a few hours while the price continues to rise and then sell it at a profit before the close of business. Investors in a mutual fund that mirrors the S&P 500 do not have this capability - by nature of the way it is traded, a mutual fund does not allow speculative investors to take advantage of the daily fluctuations of its basket of securities.
The ETF's stock-like quality allows the active investor to do more than simply trade intraday. Unlike mutual funds, ETFs can also be used for speculative trading strategies, such as short selling and trading on margin. In short, the ETF allows investors to trade the entire market as though it were one single stock.
Low Expense Ratios
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Everybody loves to save money, particularly investors who take their savings and put them to work in their portfolios. In helping investors save money, ETFs really shine. They offer all of the benefits associated with index funds - such as low turnover and broad diversification (not to mention the often-cited statistic that 80% of the more expensive actively managed mutual funds fail to beat their benchmarks) - plus ETFs cost a lot less.
Compare the Vanguard 500 Index Fund, often cited as one of the lowest of the low-cost index funds, and the SPDR 500 ETF. The Vanguard fund's expense ratio of 21 basis points is significantly lower than the 100+ basis points often charged by actively managed mutual funds. But when compared to the SPDR's 9.5-basis-point expense ratio, the Vanguard fund's expense ratio looks quite high. In fact the SPDR is 45% lower, which is tough to argue with.
Do keep in mind, however, that because ETFs trade through a brokerage firm, each trade incurs a commission charge. To avoid letting commission costs negate the value of the low expense ratio, shop for a low-cost brokerage (trades under $10 are not uncommon) and invest in increments of $1,000 or more. ETFs also make sense for a buy-and-hold investor who is in a position to execute a large, one-time investment and then sit on it.
Diversification
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ETFs come in handy when investors want to create a diversified portfolio. There are hundreds of ETFs available, and they cover every major index (those issued by Dow Jones, S&P, Nasdaq) and sector of the equities market (large caps, small caps, growth, value). There are international ETFs, regional ETFs (Europe, Pacific Rim, emerging markets) and country-specific (Japan, Australia, U.K.) ETFs. Specialized ETFs cover specific industries (technology, biotech, energy) and market niches (REITs, gold).
ETFs also cover other asset classes, such as fixed income. While ETFs offer fewer choices in the fixed-income arena, there are still plenty of options, including ETFs composed of long-term bonds, mid-term bonds and short-term bonds. While fixed-income ETFs are often selected for the income produced by their dividends, some equity ETFs also pay dividends. These payments can be deposited into a brokerage account or reinvested. If you invest in a dividend-paying ETF, be sure to check the fees prior to reinvesting the dividends, as some firms offer free dividend reinvestment, while others do not.
Studies have shown that asset allocation is a primary factor responsible for investment returns, and ETFs are a convenient way for investors to build a portfolio that meets specific asset allocation needs. For example, an investor seeking an allocation of 80% stocks and 20% bonds can easily create that portfolio with ETFs. That investor can even further diversify by dividing the stock portion into large-cap growth and small-cap value stocks, and the bond portion into mid-term and short-term bonds. Or, it would be just as easy to create an 80/20 bond-to-stock portfolio that includes ETFs tracking long-term bonds and those tracking REITs. The large number of available ETFs enables investors to quickly and easily build a diversified portfolio that meets any asset allocation model.
How to buy ETFs?
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First you need a broker, I personally use TD Ameritrade as well as Interactive Brokers. Both allow account openings of non US residents with a Malaysian address. There's others too of course which I won't mention now as I've only used these two.
Both have their own pros / cons
Initial Deposit ($ USD)
TD Ameritrade $2000 / Interactive Brokers $10,000
Trading Fees
TD Ameritrade has around 100 Commission Free ETFs although if you sell these without holding for a minimum of 30 days, you pay a $19.99 short-term trading fee. Non commission free ETFs are charged at $9.99 per trade
Interactive Brokers doesn't have any commission free ETFs but has overall lower trading fees - $0.005 per unit/share with a minimum of $1 USD, maximum of 0.5% of trade value.
Market Data
TD Ameritrade provides free live market data, no monthly fees.
Interactive Brokers charges $10 / month for US Market data, although waived if commissions reach $30 or more per calendar month. Also there's an inactivity fee if your total portfolio balance including cash is less than $100,000
Currencies
TD Ameritrade only allows funding in USD
Interactive Brokers allows funding in 18 different currencies. If you have a SGD bank account you could fund your account from there and convert within IB (rates will be far better than any bank will give)
Market Access
TD Ameritrade only gives access to US listed ETFs / Shares
Interactive Brokers gives access to many other markets outside of the US - full list with fee structure HERE
Taxation
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On opening a US based broker account, you'll need to provide a W-8BEN form which as a non US resident exempts you from paying CGT (capital gains tax).
On US ETFs you'll get Withholding tax deducted from Dividends at a rate of 30% - although half of this can be claimed back as long as you submit a 1040NR form by April 15 the following tax year.
You can also purchase Non US listed ETFs which don't have any withholding taxes. Eg. on the LSE (London stock exchange) most ETFs are domiciled in either Luxembourg or Ireland so there's no withholding taxes to pay on any dividend income. Other markets which don't have Withholding taxes on divideneds are Hong Kong and Singapore (there may be others I haven't looked into)
Funding
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Funding a US based broker account (such as TD AM or IB in USD) can be done via TT (telegraphic transfer) , the total cost including intermediary bank charges is between $40-50 overall depending on bank - this amount will remain the same regardless if you transfer $1000 or $10,000 so it doesn't make too much sense doing small amounts as these charges can be quite a significant percentage (4-5% on $1000, 0.4-0.5% on $10,000 etc.)
You can open foreign currency accounts at most Malaysian banks if you prefer to hold USD there first / change MYR > USD online on a certain date. Minimum with Maybank for FCA is $1000 (USD).
Interactive Brokers allows funding in other currencies - eg. local transfer from Singapore SGD account to IB's Citibank account in SG - no transfer charges, and it's not so difficult to open an SGD account in Singapore.
Withdrawal charges will work out around the same overall, but if you're investing for the long term they aren't really much of a concern. It makes sense to withdraw to an account of the same currency so you can choose when to convert those funds back to MYR.
Useful Links
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This post has been edited by rjb123: Jun 28 2016, 06:07 PM
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