History of Currency Exchange

8/3/2019 History of Currency Exchange

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History of Currency ExchangeThe gold standard monetary system was created in 1875. It was one of the mostimportant events in the history of the Forex market. Previously, countries used to

use gold and silver to make international payments. However, the value of goldand silver was affected by external supply and demand, which created problems.For example, if a new gold mine was discovered the price of gold would go down.

With the gold standard governments around the world agreed that they wouldconvert currency into specific amounts of gold. To do this governments wererequired to have large gold reserves to meet the demand to make exchanges. By theend of the 19th century, most of the countries with large economies had defined acertain amount of currency as being equal to one ounce of gold. As time went on,the amount of each currency that was required to purchase one ounce of gold

became exchange rates between two currencies. This was the beginning ofcurrency exchange.

Around the beginning of World War I the gold standard broke down. Europeanpowers believed it was necessary to complete large military projects because ofpolitical pressure from Germany. The cost of these military projects was so highthat there wasn't enough gold to exchange for all the currency that the governmentswere printing.

The gold standard returned briefly after World War I, however most countries wentoff the gold standard again before World War II.

Near the end of World War II the Allied nations decided to set up a monetarysystem to replace the gold standard. Over 700 Allied representatives met in BrettonWoods, New Hampshire, in July of 1944 to discuss the Bretton Woods system ofinternational monetary management. Some of the main ideas that came out of themeeting were that the US dollar would replace the gold standard and become aprimary reserve currency, that there would be fixed exchange rates and that therewould be three international agencies to oversee economic activity would be

created. These agencies were the international monetary fund (IMF), the GeneralAgreement on Tariffs and Trade (GATT), and the International Bank forReconstruction and Development.

The US dollar replacing gold as the primary standard for world currencyconversions was one of the main ideas brought about by Bretton Woods. At thetime the US dollar was the only currency that was backed by gold.

Over the next few decades, in order to remain the world's reserve currency, theUnited States had to have a series of balance of payment deficits. However, in the

early 1970s, US gold reserves had become so depleted that the United States


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treasury lacked enough gold to cover the large number of US dollars that foreigncentral banks had in reserve. So on August 15, 1971, the United States effectivelydeclared that it would no longer exchange gold for US dollars that were held inforeign reserves when US President Richard Nixon closed the gold window.

President Nixon's actions brought the Bretton Woods system to an end.

In 1976, the world decided to use floating foreign exchange rates in what wascalled the Jamaica agreement. This agreement abolished the gold standard.However, not all governments have adopted a free floating exchange rate system.In fact, most governments still use one of three exchange-rate systems. They areDollarization, a pegged rate, and managed floating rate.

Dollarization occurs if a country chooses to not issue its own currency and insteaduses of foreign currency as its national currency. One advantage of dollarization is

that the country may be seen as a relatively stable place for investment. Twodisadvantages of dollarization are that the country's central bank can no longermake monetary policy nor print money.

Pegged rates happen if a country chooses to directly fix its exchange rates to aforeign currency. Pegged rates usually allow the country to have more stabilitythan a normal float. The country's currency may be pegged at a fixed rate to asingle currency or to a specific basket of foreign currencies. The currency onlyfluctuates when there are changes in the pegged currencies. An obvious example ofa pegged currency is the Chinese yuan. Between 1997 and July 21, 2005 theChinese Yon was pegged to the US dollar at a rate of 8.28 yuan.

Managed floating rates are created when a country's exchange rate changes freelyand the currency f value is subject to the forces of supply and demand in the

market. With managed floating rates the country's central bank or government

may intervene when there are extreme fluctuations in exchange rates. If, forexample, a country's currency depreciates too much, the government couldincrease short-term interest rates, which would likely cause the currency toappreciate. Central banks generally have a wide variety of tools that they can use to

manage their currency.

Participants in the Forex Market

Market participants in the equities market are often limited to investors who tradewith either other investors or institutional investors like mutual funds. On theForex market, however, there are market participants who are not investors.

Governments and central banks are probably the most influential participants in thecurrency exchange market. Many countries use their central banks as an extensionof the government to conduct monetary policy. Other countries seem to believe


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their central banks would be more effective in finding a balance between keepinginterest rates low and curbing inflation if they were more independent, and free ofgovernment control. In both cases, though, representatives from the governmentusually have regular meetings and discussions with the representatives of the

central banks, leading, often, to similar ideas on monetary policy.

Reserve volumes are often manipulated by central banks in attempts to meeteconomic goals. China, for example, has been purchasing millions of dollars ofUnited States treasury bills to keep the Chinese Yuan at its target exchange rate, aresult of China pegging its currency to the US dollar. Central banks adjust theirreserve volumes by participating in the foreign exchange market. Because thesebanks have a great deal of purchasing and selling power, they have a largeinfluence on the direction of the currency markets.

Banks and other financial institutions are some of the largest participants in Forextransactions. The interbank market is where large banks conduct transactionsamongst themselves. These transactions determine the currency. The interbankmarket is huge in volume when compared to the exchange individuals make whenthey need small-scale foreign currency transactions. Credit is the basis of theelectronic brokering systems that allow the banks to transact with each other. Theonly banks that can engage in transactions are ones that have great relationshipswith each other. Larger banks generally have a wider array of credit relationshipsand therefore can access better pricing for their customers. On the other hand,small banks with fewer credit relationships often have lower priority in pricing. Wecan think of banks as being dealers because they are willing to buy or sell acurrency at the ask or bid price. Banks are able to make money by charging apremium to exchange currency on the Forex market. The Forex market isdecentralized so frequently different banks have slightly different exchange ratesfor a given currency.

401(k)

401(k) and Qualified Plans: Introduction

(Retirement plan details change frequently. TeachMeFinance.com is intended for educationalpurposes only. TeachMeFinance.com is an informational website, and should not be used as asubstitute for professional financial, legal or medical advice. Please contact your attorney oraccountant before making actual investment or retirement decisions. Also please readourdisclaimer.)

Retirees normally receive their income from one of the following three main sources:

Benefits from the social security system
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Their regular savings account A retirement plan (for example, IRAs or employer-sponsored plans)

In some cases, employers will establish a qualified plan which is the mechanism that

handles the retirement benefits for their employees and their families. Whereas SEP andSIMPLE IRSs are linked to the IRA, a qualified plan has no connection to the IRA andtherefore it does not need to abide by the same regulations regarding contributions anddistributions. Businesses can choose to set up a qualified plan or an IRA-based plan. Thisdecision will generally be made based upon how much the business is prepared to contributeand if they want and have the capacity to administer the plan. Qualified plans are moredifficult to administer than SIMPLE IRAs or SEP. Qualified plans can be defined either bytheir benefits or contributions. Employers receive tax deductions in return for thecontributions that they make to the plan. Employees are generally not required to pay taxeson the assets in the plan until after distribution. Another advantage is that earnings are taxdeferred with qualified plans. For a plan to have qualified status, it is required to complywith the requirements set out in the Internal Revenue Code (IRC), the Employee RetirementIncome Security Act 1974 (also known as ERISA) and the Department of Labor (DOL).

Defined-Benefit Plans

A defined-benefit plan is a qualified plan in which the retirement benefits that an

employee receives are based on their personal characteristics, such as their

compensation, age and years of service. An example of this is a plan that says that

when an employee retires, his or her benefits will be 1% of the average salary that

they received in the last five years with the company for the same period of time

as their length of service. Another option is that the plan may state the exactamount (for example, $200 a month) of the benefit.

EXAMPLE: John spent 10 years working for ABC Company. He earned $65,000 in

2004, $70,000 in 2005, $80,000 in 2006, $90,000 in 2007 and 100,000 in 2008.

This means that his average salary for his last five years was $81,000. In turn, that

means that 1% of his last five years average salary is $810. According to the plan,

John is entitled to receive $810 for the same number of years that he worked for

the company, that is, for 10 years.

This is the predetermined retirement benefit and the employer is required to

make contributions to equal this amount. In making these contributions they will

use actuarial assumptions that take into account the expected investment

growth. When the investments made by the plan fail to perform and do not reach

the required amount, the employer must contribute more to make up the

balance. Contribution limits are much higher for defined-benefit plans than

defined-contribution plans. Operating a defined-benefit plan will usually require

actuarial assistance as it is based on formulas and actuarial assumptions.


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Defined-Contribution Plans

With a defined-contribution plan, the specific amount that the employee will

receive when they retire is not promised. Employees, employers or (in some

cases) both make contributions to these plans. The contribution is usually apercentage of the employees compensation package. The employer

contributions may be compulsory or discretionary, depending on the type of plan

used. The plan will invest the contributions on behalf of the employee. The

benefit that they will receive upon retirement is based on the contributions that

were made and the investment results (earnings or loss). In these types of plans,

employers dont have to compensate for the possible loss on the investments.

These plans may take the form of a profit-sharing plan, a 401(k) plan, an ESOP

(employee stock ownership plan) or a money-purchase pension plan.

Plan Definitions

Profit-Sharing or Stock-Bonus Plans

As the name suggests, a profit sharing plan is used by businesses to share profits

with their employees. Employers are able to make these types of contributions

whether or not the business actually profited during the year. These contributions

will usually be discretionary, meaning that the employer decides whether or not

they want to contribute to the plan in a particular year. Although this may seem avery flexible system, the employer cannot let too many years pass without making

a contribution. The IRS doesnt exactly specify the number of years that are

allowed, but there are requirements that the contributions must be recurring and

substantial.

With a stock-bonus plan the employer will use stock in the company to make

contributions or distributions. These types of plans cannot be used by sole

proprietorships or partnerships.

Profit-sharing plans and stock-bonus plans can have a 401(k) feature. These plans

are well suited for newly established employers who are unable to accurately

predict their future profit levels or who would like their contributions

requirements to be flexible.

Money-Purchase Pension Plan

Generally speaking, money-purchase and defined-benefit plans have less flexible

contribution requirements than profit-sharing plans. Money-purchase plans have

fixed contribution levels that are not related to the profits of the business. Forexample, if the plan says that members will receive 10% of their compensation,


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then the employer must contribute that amount regardless of the companys

profits. These types of plans suit employers that have a clear picture of their profit

trends and who dont mind making compulsory annual contributions.

401(k) Profit-Sharing Plan

In a 401(k) plan employees can defer receiving a portion of their compensation

and elect to have that amount put into their plan. This is also commonly known as

CODA, which stands for cash or deferred arrangement. The deferred

contributions (also known as elective deferrals) are usually made to the plan

before tax. Employers will choose the type of plan that they use and it could

either be a stand-alone 401 (k) plan or a plan that combines profit-sharing with

401(k). The employer will also choose whether they want to make additional

contributions to the plan. 401(k) plans are designed for employers that want theiremployees to help with the plan funding.

Age-Weighted Plans

An age-weighted feature can also be added to retirement plan. This basically

means that an increased proportion of the plan contributions will be allocated to

older employees. This is based on the assumption that these older employees are

going to retire sooner and have less time to build their savings. These plans suit

situations where the business owners are much older than the employees andthey have not yet accumulated sufficient retirement savings.

Employee Stock Ownership Plans (ESOPs)

ESOPs are a type of defined-contribution plan which involves investments

primarily in stock of the company. These plans were authorized by Congress in

order to encourage increased employee involvement in corporate ownership.

Why Establish a Qualified Plan?

Choosing the most suitable retirement plan is a business decision with hugefinancial implications. The plan needs to suit the immediate needs of the employerand to be consistent with their business and financial profile. Qualified plansbenefit both employers and employees.

Benefits for Employers

Some plans offer employers tax deductions when they make contributions It may enable the employer to attract and retain the best employees. A

qualified plan may be the factor that makes a sought after employee selectone company over another.


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In some situations the employer can claim a tax credit to cover part of thecosts of establishing the plan. This is only possible if the expenses wereincurred after December 31, 2001. The maximum credit available is $500for the initial three years of the plans operation. This covers 50% of the

establishment, administration and employee education expenses.

Benefits for Employees

Employees have peace of mind from some guarantee of their financialsecurity in retirement.

Where the plan involves a salary-deferral feature, the employee can deferpaying tax on the amount of compensation that they contribute to the planuntil it is distributed. At this time their tax bracket will probably be lower so

overall they will pay less tax. In some plans employees are permitted to take out loans from the plan.

Interest on the loan is credited to the employees account. This makes it a

better option that loans from a financial institution where the interest goes tothat institution.

401(k) and Qualified Plans: Eligibility Requirements

Any type of business can set up an establishment plan. It doesnt matter if the

business is a sole proprietorship, a partnership, or corporation of a governmententity. Employees cannot set up a qualified plan. The plan must be established bythe employer.

Establishing a Qualified Plan

A qualified plan normally is made up of two documents: 1) the adoption agreementand 2) the plan document. The plan document sets out the provisions of the plansoperation. The plan is formally adopted when the employer passes a resolution

which says that they are adopting the plan. They will then complete the adoptionagreement and issue a summary plan description (SPD) to employees. The SPD isrequired to be written in plain language so that all employees are able tounderstand it clearly. The SPD must include the following information:

the plans location and identification number how the plan will operate and what it will provide for employees when it will commence how the benefits and length of employee service will be calculated under the

plan

when the employee will be entitled to their benefits when and how employees will receive their benefits


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how benefits should be requested possible situations where employees could be denied or lose their benefits rights of the employee under ERISA

It is important that employees read the SPD so that they are aware of the provisionsof the plan that apply to them. When the plans provisions change, the employermust issue a revised SPD or a new document known as a summary of materialmodifications (SMM).

Choosing a Plan Provider

Employers have the option of establishing their own plan that is specificallydesigned for their business or choosing a plan designed by a sponsoring

organization that has been approved by the IRS.

Individually Designed Plans

The point of an individually designed plan is to meet the specific needs of aparticular employer. No other employers are permitted to use this document. Thesetypes of plans are typically used by large companies that have certainspecifications in mind for their plan that they cant get from a prototype.Individually designed plans are not required to be approved in advance by the IRS,, however, the employer can apply for IRS approval if they want to be assured thatthe plan satisfies the regulations. They will need to pay a fee and ask for adetermination letter. Lawyers and tax professionals are normally involved indrafting new plans and their fees will vary.

Master or Prototype Plans

Small businesses are often attracted to master or prototype plans that have alreadybeen approved by the IRS so there is no need to apply and pay for a determinationletter. These types of plans can be used by more than one employer. In master

plans, the operator will set up one trust or custodial account that will be used by allemployers that adopt the plan. In prototype plans, separate trusts or accounts areset up for each employer. Several different types of organizations can sponsormaster or prototype plans including:

banks (this includes certain approved federally insured credit unions andsavings and loan associations)

trade unions or professional organizations mutual fund or insurance companies attorneys, financial planners or accountants


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Establishment Deadline

Qualified plans are required to be established before the final day of the

employers tax year. The employer is required to make contributions for that yearand all subsequent years according to the provisions in the plan.

Eligibility Requirements for Employees (Plan Participants)

There are specific requirements that employees must meet in order to participate inthe plan. It is important that business owners dont implement requirements thatwould mean that they cannot participate in the plan. For example, if a businessowner is 19 years old then a requirement that plan participants be over 21 wouldmean that he or she is excluded. Qualified plans will generally have the following

eligibility requirements for employees:

The employee is over age 21. The minimum age of a plan cannot be more than 21and employees under this age can be excluded. Maximum age limits are notpermitted, meaning employees cannot be excluded for reaching an upper age limit.

The employee has been working for the company for at least one year. For plansother than 401(k) plans, this requirement is increased to two years of service.These plans also provide that after service of less than two years the contributionswill be vested and the employee will have a non-forfeitable right to the total of hisor her benefit. According to a qualified plan, one year of service is usuallyequivalent to 1,000 hours of service per plan year. Employees who dont work1,000 hours in a year are not considered to have worked for one year even if theyworked over a 12 month period.

Exceptions to these eligibility requirements may be implemented by employers(for example, they may reduce the minimum age or change the required hours ofservice). There are some eligibility criteria though that must conform to theregulations governing qualified plans. Employers must consult with a lawyer

regarding eligibility requirements that havent been approved by the IRS beforeimplementing the plan.

Excludable Employees

Employers are permitted to exclude certain employees from the plan, for examplethose who are unionized or nonresident aliens.

Vesting - Employees Non-Forfeitable Rights to Employer Contributions

The term vesting refers to the process whereby the employee becomes entitled to


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a non-forfeitable right to access the benefits that their employer has contributed.Vesting schedules have been set up to meet regulatory requirements and qualifiedplans need to abide by these requirements. Employees will always have vestingrights in relation to the contributions that they make to the plan. There are two

different type of vesting schedules that an employer can choose from. They are:

Cliff Vesting. With a cliff-vesting schedule the employee is required to stay withthe company for three years of service before the employer contributions will beconsidered vested. Following three years, these contributions will be 100% vested.

GradedVesting. With graded-vesting schedules, the employer contributions willbecome 20% vested after the employee has completed two years of service. Thevesting then increases by 20% in each subsequent year until it gets to 100%. Thiswill occur following six years of employee service.

Copyright 2011 byMark McCracken, All Rights Reserved

Exchange-Traded Funds (ETFs)

Exchange-Traded Funds (ETFs)

(Examples of funds are listed, but this listing in no way implies a recommend to invest in

particular funds. TeachMeFinance.com is intended for educational purposes only.TeachMeFinance.com is an informational website, and should not be used as a substitute forprofessional financial, legal or medical advice. Please contact your attorney or accountantbefore making actual investment decisions. Also please read ourdisclaimer.)

ETFs are generally considered to be a good investment option for all levels of investors, fromvery experienced money managers to people who are getting started cresting their portfolio.ETFs can be used as the sole component of an investment portfolio. It is possible to create adiverse portfolio that consists only of a few ETFs. Alternatively, ETFs can also be used inconjunction with other investment strategies. Like any other investment option, it is essentialthat investors understand how ETFs work and how they should be used.

ETFs are quite straightforward investment vehicles. They trade similarly to stocks and appearto be similar to mutual funds. The performance of an ETF is based on an underlying index.There are some structural differences between an ETF and a mutual fund. There are alsodifferences in the way that these two types of funds are managed. ETFs are more passivelymanaged due to the fact that they track an index. Investors with mutual funds will normallyuse a more active management style. An index mutual fund (for example, the S&P 500) andan ETF based on tracking the same index (for example, the SPDR S&P 500 ETF) would beconsidered equivalent from an investment point of view. These two funds would performvery similarly. The main difference is availability. Mutual funds are generally only availablefor major indexes, while ETFs are available for a larger range of indexes giving more

investment options.
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ETFs are a lot more recent than mutual funds. The first ETFs in the United Stateswere the S&P 500 depository receipts. These were launched by State Street GlobalAdvisors and are commonly referred to as SPDRs or spiders. Originally, ETFswere available to track broad market indexes, however the application of ETFs has

now spread into different sectors, commodities, currencies and global investments.Morgan Stanley has released information claiming that, at the end of 2007 therewere 1,171 ETFs in existence throughout the world and the combined value ofthese ETFs was $800 billion. An ETF basically means that you have a share inowning a unit investment trust (UIT). A UIT holds diversified portfolios consistingof a range of stock, bonds, commodities and currency.

Comparisons are often made between ETFs and mutual funds. These include:

Both ETFs and mutual funds involve the pooling of the assets held byinvestors. Professional managers are then used to invest the money in waysthat are designed to meet clear objectives (for example, capitalappreciation). Both types of funds will also have a prospectus. Purchasers ofan ETF will receive a prospectus and investors are provided with a productdescription which outlines the important ETF information.

When an investor purchases or redeems from a mutual fund, they do soaccording to the NAV (net asset value) of the fund. The NAV is calculatedon a daily basis. When an investor buys an ETF the shares are purchased onthe stock exchange in the same way as any other listed stock. There are alarge number of index mutual funds that are available and they are usuallyactively managed. ETFs are usually passively managed because they trackaccording to specific indexes, but there are a few actively managed ETFs.

ETFs and mutual funds have opposite creation and redemption processes.With mutual funds, interested investors send cash to the company that ismanaging the fund and it is used to purchase shares and securities which areissued to the fund. When it comes time to redeem, the investor is paid cashfor the return of the shares to the mutual fund. The ETF creation processdoes not involve cash at all.

Creation

When an ETF is created, the investor is issued a security certificate that says thatthey have the legal right of ownership in relation to part of a collection of stockcertificates. Before an ETF can be created in the United States, a fund manager isrequired to send a detailed plan outlining the procedures and composition of thefund to the Securities and Exchange Commission (SEC). Generally speaking, thiscan only be done by the biggest of the money management firms because theyhave the best contacts (in terms of major investors, international money managers

and pension funds) that are required to create ETFs. These firms are also able tofacilitate the demand for new ETFs (either with institutional or retail customers).


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The next step in the creation process involves a middleman (known as anauthorized participant, market maker, or specialist) assembling the collection ofstocks. They will usually assemble enough to purchase between 10,000 and 50,000ETF shares. These shares (known as the creation unit) are delivered to a custodial

bank who then forwards them to the market maker.

Redemption

When an authorized participant wants to redeem shares they will buy a largeamount of ETFs and send them to the designated custodial bank in return for anequal amount of individual stocks. These shares are generally returned to theinstitution from which they came, but they can also be sold on the stock exchange.There are two ways for an investor to redeem an ETF:

They can submit the shares to the fund that is managing the ETF in returnfor the underlying shares.

They can simply sell the ETF to another investor on the secondary market.

In most cases investors will choose the second option. This difference inredemption methods is one of the biggest differences between ETFs and mutualfunds. ETFs cannot be called mutual funds because of the limited options toredeem them.

Arbitrage

The opportunity for arbitrage is one of the most distinctive and importantcharacteristics of an ETF. In a situation where the price of the ETF begins to splitfrom the NAV of the stocks that it is comprised of, participants are able to takeactions to profit from the differences. If the shares in an ETF are trading for a pricethat is lower than the NAV, then the shares are bought by arbitrageurs on the openmarket. The arbitrageurs use the shares to make new creation units which are thenredeemed with the custodial bank in return for the underlying securities. When

ETF shares are trading for a higher price than the NAV, the arbitrageurs purchasethe underlying securities. These are then redeemed for creation units and the ETFshares are sold to make a profit. Arbitrageur actions mean that ETF prices and theunderlying NAV remain very similar.

Popular Types of ETFs

SPDRs SPDRs stands for Standard & Poors Depositary Receipts. These are

managed by a firm called State Street Global Advisors (or SSgA). SPDR S&P 500EDF is the most popular in the range of SPDRs available. There are also ETFs that

track each of the main S&P 500 sectors. These are known as Select Sector SPDRs.


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iShares iShares is a type of ETF that is managed by Barclays Global Investors.This money management firm is the largest global provider of ETFs (according toresearch conducted by Morgan Stanley). They provide ETFs in a broad range ofsectors both in the US and internationally, including various industry sectors,

commodities and fixed income.

Vipers VIPERS stands for Vanguard Index Participation Receipts and these ETFscover a broad range of different industry sectors, international ETFs and bondETFs. These types of ETFs are issued by Vanguard, a firm that is well known foroffering a wide choice of index mutual funds.

PowerShares This is a new player in the ETF market. Powershares most popularETFs are the QQQQ or Nasdaq 100 ETF. They also offer ETFs that arequantitatively based, meaning that they use dynamic indexing to constantly find

the stocks that are performing the best in each index. Powershares offer ETFs inindustry sectors, the broad market, fixed income, international indexes,commodities and currency.

Features

Most ETFs will track a particular index. This means that their performance willalways be very similar to the index fund, but not exactly the same. Sometimesthere will be a difference between the returns of index and the fund. This is knownas a tracking error which will occur as a result of inconsistent composition,management, expenses, and dealing with dividends. These factors are consideredin further detail below:

Small investors can benefit from trading in ETFs

Buying and Selling ETFs Can Be Good for the Small Investor

ETFs have continuous pricing, meaning that they can be traded on the stockexchange at any time during the trading day. With ETFs you can place an order

such as a limit order or a stop loss order in the same way that you would withindividual stocks. You can also sell ETFs short. There is a difference in the pricingof mutual funds and ETFs. The prices of mutual funds are determined by the netasset value (NAV) that they have at the end of a trading day. ETFs, on the otherhand, are priced according to the market prices that are listed on the exchange.These are similar to, but independent of, the NAV. The actions of arbitrageursmean that the values of ETFs and the NAV will remain very similar. Its possible

for investors to purchase just one share of anETF, however most will buy a boardlot. Purchases of less than a board lot are much less cost-efficient for investors.Investors are able to buy ETFs from anywhere in the world. This is another

advantage when compared to mutual funds, as mutual funds can usually only be


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bought where they are registered.Treatment of Dividends

Dividends from the underlying stocks of an ETF are typically paid out each

quarter. The underlying stocks may pay dividends several times during thequarter, meaning that the fund is holding cash. This occurs regardless of the fact

that the underlying benchmark is not made up of cash. When an ETF pays a

dividend, the cash is sent to the investors brokerage account just like it would be

with regular stock. To reinvest that amount, the investor is required to make

another purchase.

Tax Efficiency

ETFs will usually offer investors bigger tax benefits than a mutual fund becausethey are passively managed. The low turnover of securities means that the

generated capital gains are much smaller and less frequently realized than with an

actively managed fund. Securities in an index ETF are only sold when there is a

change in the underlying index. A mutual funds e unrealized capital gains

accumulate when the stock rises in value. The capital gains are then distributed

proportionately to investors when the fund decides to sell the stocks. This means

that these investors have to pay higher taxes.

Transparency

Because ETFs closely replicate the actions of the index or commodity to which

they are linked, investors are always aware of the value of what they are buying

and what the ETF is comprised of. The fees are also a lot more obvious with ETFs.

Mutual funds are only required to report what stock they hold twice annually

which means that there is not as much transparency for investors.

Fees and Commissions

One of the principle advantages of an ETF, when compared to a traditional mutual

fund, is the low annual fees that they charge. The passive management structure,

reduced expenses of marketing, distribution and accounting, are all factors that

mean that ETFs have lower fees. One possible problem is the fact that investors

will have to pay a brokerage fee each time that they buy or sell shares in an ETF.

When an investor is doing this often it will dramatically increase the cost involved

in their ETF investment. However, new budget brokerage fees are now becoming

more common, meaning that ETF trading is more cost efficient for small or

frequent purchases.


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Options

Several ETFs now come with tradable options. These can be used together with

the underlying ETF to formulate new investment strategies. Using these strategies

investors can create additional leverage in their portfolios.

SPDR S&P 500 ETF

The SPDR S&P 500 ETF is the original ETF in the United States and it is now the

most popular. This ETF is managed by State Street Global Advisors and it tracks

the S&P 500 Index which is one of the most popular indexes throughout the

world. State Street Global Advisors are one of the largest ETF management firms

in the world.

SPDR S&P 500 ETF Objective

The purpose of the SPDR S&P is to mirror the S&P 500 Index as closely as possible

in terms of the value of the return before expenses. In 2008 there were 525

million outstanding shares on the S&P 500 Index and it had a total net asset value

of just over $73 billion. The S&P 500 Index is available to be traded on the

American Stock Exchange (the AMEX) where it is represented by the letters SPY.

SPY is one of the most popular stocks on the AMEX. It trades over 100 million

shares each day. On particularly busy days it can trade more than 400 millionshares.

Characteristics of the S&P 500 Index

The S&P 500 is an index that is made up of the market capitalization trading of

500 companies that are the largest in the United States. This index represents

approximately 75% of the total equity market capitalization in the United States,

according to Standard and Poors, and is referred to as a large cap index. There

are 10 industrial sectors represented in the index according to the GlobalIndustrial Classification Standard (GICS).

Performance of SPDR S&P 500 ETF

The annual returns of both the S&P 500 Index and the SPY ETF are provided.These returns refer to the returns for the designated periods as of April 30, 2008.

1 year, S&P 500 Index -4.68% , SPY ETF 4.67%. 3 year, S&P 500 Index 8.23% , SPY ETF 8.16%. 5 year, S&P 500 Index 10.62% , SPY ETF 10.56%. 10 year, S&P 500 Index 3.89%, SPY ETF 3.78% .


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As illustrated in the above table, there is a very close relationship between the SPYETF and the S&P 500 index. The slight difference results from the higher expensesthat are incurred by the SPY. Many investors consider SPY to be a good equity

holding to have partially due to the fact that its expense ratio is quite low.

EXAMPLE: Assume that on May 21, 2008 an investor buys 300 shares for aclosing price of $129.75 each. This would cost $38,925.00 with the commissionnot included. The expense ratio of this transaction is .0945%. This adds about $37to the annual cost for the investor.

Investors may purchase the SPY in order to give exposure to the US stock marketin his or her portfolio. In other cases, an investor may want to combine the spywith other ETFs to create a customized exposure in relation to US stocks. The ETF

can also be actively traded. Its popularity means that it is very easy to liquidate andit can be bought and sold regularly without incurring large extra costs.

Active Vs Passive Investing

Indexing has been very popular with institutional investors for some time , but ithas only recently been used by individual investors. The first issue for investors toconsider is whether they want to adopt a passive or active investment strategy.Indexing and trading in ETFs are predominantly considered to be passivestrategies.

Rationale for Active Investing

Most investors these days use active investment strategies in an attempt to profitfrom outperforming the market. Active management techniques are based onbeating a specific market benchmark. Most mutual funds adopt an activemanagement strategy. Active managers devote a lot of time to gatheringinformation and insights (based on market trends, economic factors and company-specific data) on which to base their investment decisions. The ultimate goal of

these investors is to outperform the market and many of them will use complicatedsystems to guide their security selection and trading. These active managers use awide variety of different active management methods which are generally based ona combination of fundamental, technical, quantitative or macroeconomic analysis.Active managers try to use their insight to exploit any inefficiencies, anomalies orirregularities that may exist in the capital markets. Prices on the capital market aregenerally quite slow to react to new information and this allows fast and skillfulinvestors to profit.

Rationale for Passive Investing


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A passive management strategy is based on making exactly the same investment(the same securities and proportions) as an established index like the S&P 500 orthe Dow Jones Industrial Average. This is also referred to as indexing. In thesecases the managers of the portfolios are not required to make any decisions at all

about which securities they will buy and sell. They are simply applying identicalinvestment methodology as the indexes, and is called passive investing. Thepassive manager is attempting to match the performance of the index. These typesof investors will invest in a wide variety of the market using different indexes orasset classes. They are prepared to accept the average return produced by aparticular asset class. This investment strategy is based on the efficient markethypothesis (commonly referred to as the EMH). This theory is based on a rationalethat the market is quick to reflect available information and therefore prices willalways be fair. Investors who believe in EMH think that it is very difficult for anytype of investor (large or small) to consistently outperform the market. Their goal

is not to outperform the market, just to match it.

Which is better? - Passive or Active Management

This has been a topic of debate since the 1970s. Academic researchers atuniversities and other private research institutions argue in favor of passivemanagement strategies. Banks, insurance companies and Wall Street firms supportactive management strategies because they have a vested interest in profiting fromthis type of investment. Logical arguments can be made by both sides. Thedifference generally comes down to different philosophies, similar to the differencebetween political parties. The advantages and disadvantages of both sides arebriefly outlined below:

Active ManagementAdvantages and Disadvantages

ADVANTAGES:

Active managers can use their superior skills to outperform the index.Making informed decisions resulting from research, knowledge and

experience means that their investment decisions will frequently lead togood performance. Active managers are able to execute defensive strategies to guard against a

market downturn. If they foresee a market downturn, they can hedge orincrease their cash positions so that their portfolios are not affected toobadly.

DISADVANTAGES


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There are higher costs (fees and operating costs) involved in activeinvesting. This factor can impede the consistent long term performance ofan active manager.

Active managers will generally have portfolios that concentrate on a smallerbase of securities. This means that if their investment decisions are wrongthey could under-perform significantly. Their investment decisions may notreflect market reality for an extended period of time, meaning that theirportfolio fails to perform.

Passive ManagementAdvantages and Disadvantages

ADVANTAGES

Passive investing will always closely match the index performance level.The strategy is based on tracking the chosen index as efficiently as possible.

The manager is not required to make very many decisions in relation to theinvestments.

This strategy has much lower operating costs and the investor benefits fromthis by having to pay much lower fees.

DISADVANTAGES

The performance of a passively managed investment will never exceed theunderlying index that it is tracking. The investor must be happy to be limitedby the performance of this index.

There is nothing that passive investment managers can do if they foresee ageneral market decline or if they want to sell individual securities.

Index Funds Vs. ETFs

In many ways, it can be very difficult to compare mutual funds (actively managed)and ETFs (passively managed) because they have completely differentcharacteristics. If an investor wants to utilize a passive investment strategy, then heor she should consider the best way for it to be implemented. This will involveusing either index funds or ETFs.

Index Funds and ETFs

Index funds have been available in the United States for a lot longer than ETFsIndex funds were first traded in the 1970s and ETFs in 1993. The number of ETFs

and index funds now in existence is very similar, but ETFs have a much broaderspread (they cover around 5 times more indexes than index funds). There are some


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indexes where it is more appropriate that they are covered by an ETF than an indexfund and these are usually dealt with by newer ETF structures. This means thatsome indexes can only be tracked using an ETF because there is no available indexfund for that particular index.

Costs

Index funds and ETFs have distinct advantages and disadvantages in terms of thecosts involved and this can often be the factor that makes one preferable to theother. No-load index funds can be purchased free of any transaction costs. ETFs,on the other hand, require the payment of brokerage commissions.

Tax Efficiency

In most cases, an ETF will have greater tax benefits than the equivalent index fund.This is due to the creation and redemption processes for ETFs and the fact thatthese processes eliminate the selling of securities. Index funds involve the buyingand selling of securities which results in the distribution of capital gains to unitholders. Even though index funds have lower turnover than other type of activemanaged funds, they still result in higher taxes than an ETF.

Dividends

ETFs accumulate and distribute dividends and interest from the securities toshareholders on a quarterly basis. Index funds do not accumulate dividends orinterest but immediately invest them.

Rebalancing

People who invest in ETFs and index funds will sometimes want to rebalance theirportfolio. This involves selling some positions that they hold and purchasing newones. When investors want to rebalance their ETFs they will have to paycommissions for each sale and purchase. It will also be very difficult for this

investor to get the exact proportion of ETFs that they want because ETFs aregenerally traded in board lots. It is even more difficult for small portfolios. This isnot a problem with index funds because the investor is able to buy fractional units.This means that they can get the exact weightings that they want. There isnotransaction costs involved in no-load funds.

Dollar-Cost Averaging

Attempting to use dollar-cost averaging (that is, trying to spend a designatedamount on your portfolio at regular intervals) is generally considered to be

impractical for ETF trading. It becomes very expensive to implement this


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technique, due to the commissions and the additional costs of buying odd-lots.Dollar-cost averaging, as an investment strategy, is better suited to mutual funds.

Liquidity

The costs of ETF trading are also increased by their lack of liquidity. This lack ofliquidity has the effect of increasing the bid-ask spread. Smaller and less popularETFs are also unlikely to attract the same level of interest from arbitrageurs whichmeans that there may be a large difference between the net asset value of the stocksand the prices on the market. With index funds, this difference doesnt exist andinvestors will always get the end of day NAV.

Equity ETFs

ETFs were originally developed so that portfolios could be diversified and linkedto equity indexes. Equities make up a core asset class for investors so it is veryimportant that investors are aware of the different ETF options that are availablebefore they invest.

Broad-Based U.S. ETFs

Broad-based ETFs (also known as total market ETFs in the United States) coverthe entire US equity market. Popular indexes, such as the S&P 500 and the DowJones Industrial Average, cover only a section of the whole market. The S&P 500,for example, represents around three-quarters of the US market capitalization. Atotal market ETF has a broader reach and enables investors to cover all US equitiesusing a single ETF. These types of ETFs are usually inexpensive as well as havinglow expenses and narrow bid-ask spreads. They are also a lot less volatile thatETFs that are more focused. Three of the most popular broad-based indexesinclude:

SPDR DJ Wilshire Total Market ETF iShares Russell 3000 Index Fund iShares Dow Jones U.S. Total Market Index Fund

All World ETFs and All World Excluding U.S. ETFs

It is also now possible for investors to diversify their portfolio to cover globalequities by investing in an all world ETF. These ETFs cover most stock exchangesthroughout the world. There are different types of global ETFs available dependingon whether you want to include the US market (all world ETFs) or exclude the USmarket (all world ex-US). The all world excluding US option is generally preferred

by investors who already own US stocks. Examples of these types of ETFsinclude:


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iShares MSCI All Country World Index Fund ETF SPDR S&P World ex-US ETF

Developed Versus Emerging Markets

There is a considerable difference in the characteristics of stocks that are availablein the developed world compared to those in emerging markets. These are similarto the differences between large and small cap stocks. When thinking about thebest way to construct a portfolio, it makes good sense to consider the threefollowing entities separately:

US equities Developed countries excluding the US (Europe, Australia, Far East ) Emerging markets

Sector ETFs

With sector ETFs an investor is able to invest in stocks in several differentindustrial sectors. These can be used either to build a diverse portfolio, or to investin a specific industry (for example, energy or technology). Using sector ETFs tobuild a portfolio means that you have a greater ability to fine-tune the portfoliocreation than you would with a broad-based ETF. The portfolio can also be easily

rebalanced regularly. The performance of the portfolio can also be improved byselling sectors that have performed well and buying sectors that haveunderperformed. With sector ETFs you are able to avoid trading in industrialsectors that are overvalued. These types of ETFs are usually more expensive, andhave higher operating costs, than broad-based ETFs. It is advisable not to blenddifferent industrial sectors when you are trading in ETFs. Two examples of sectorsETFs are:

Barclays iShares Dow Jones Sector ETFs State Street Global Advisors S&P Sector ETFs

Market Capitalization ETFs

Stocks can also be divided into three separate categories according to their marketcapitalizations. These categories are small, mid and large cap stocks. Investors areable to fine tune their portfolio by investing in ETFs that cover each of these threecategories. This gives a wider opportunity for customization. The family of ETFsshould not be mixed when adopting this approach. Three examples of these

different market cap ETFs are:


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SPDR DJ Wilshire Small Cap ETF SPDR DJ Wilshire Mid Cap ETF SPDR DJ Wilshire Large Cap ETF

Growth and Value ETFs

Investors can also choose to purchase ETFs that are either value or growth stocks.Value stocks generally seem to be a relatively inexpensive option. They have a lowP/E ratio, high-dividend yield and the price to book value is much lower than otherETFs. When looking at the current fundamentals growth stocks seem moreexpensive, however it is assumed that they will produce higher earnings, dividendsand value in the future. An entire market ETF provider categorizes stock as beingvalue or growth stocks so they will appear in only one ETF. Examples of these

types of ETFs include:

iShares Russell 3000 Growth Index Fund iShares Russell 3000 Value Index Fund

Leveraged ETFs

Leveraged ETFs are one way to invest in broad market indexes in the US with ahigher level of volatility. One example of a leveraged ETF is the ProShares Ultra

S&P 500 ETF, which is the leveraged version of the S&P 500. Investing in thisleveraged ETF means that if the value of the S&P 500 increases by 1%, the valueof the Proshares ETF will increase by 2%. This also applies to decreases in value.A leveraged ETF is different to a regular ETF in that it uses options and futuresrather than index stocks. Futures provide a higher level of leverage and the extracash that this generates is used to buy bonds. The bond investment covers therunning costs of the ETF and increases the dividends that are paid to the investors.

Active traders often use leveraged ETFs to trade in short-term movements on the

market. Leveraged ETFs are also used to gain access to increased index exposurewithout getting into debt. Retirement accounts will also often use leveraged ETFsas these accounts are usually prohibited from engaging in margin lending. Theexpense ratios for leveraged ETFs tend to be higher than standard ETFs. Threepopular leveraged ETFs are:

ProShares Ultra S&P500 ETF ProShares Ultra QQQ ETF ProShares Ultra MidCap400 ETF

Quantitative ETFs


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Quantitative ETFs give investors the capacity to outperform an index. They do thisby using enhanced indexing. A set of predefined rules are used to rank stockswithin an index based on a variety of characteristics. This ranking process uses

both technical and fundamental factors to indentify a group of stocks in an indexthat are more likely to perform well. The best stocks are then selected and used toform a new index. The new index is made up of a small group of stocks and thesecan be rebalanced each quarter in order to reflect rankings changes. Another typeof quantitative indexing is the fundamentally-weighted index. This is not based onmarket capitalization, but instead uses cash flow and earnings to value stocks. Adisadvantage of investing in a quantitative ETF is that the stocks that it includesare not visible. This makes creating a diversified portfolio a difficult process. Thequarterly rebalancing also means that there may be more trading of stock whichwill result in higher expenses as well as reducing the tax efficiency. Quantitative

ETF examples include:

First Trust Large Cap Core AlphaDEX Fund PowerShares Dynamic Market Portfolio

Fixed-Income and Asset-Allocation ETFs

Since their creation (as an alternative way of trading equities), ETFs providershave broadened their scope to now include bond and asset allocation ETFs. Asset

allocation refers to those ETFs that encompass a range of different classes ofassets.

Fixed Income ETFs

One disadvantage of bonds is that they lack the liquidity and transparency ofequities. Also, bonds are not traded on an exchange in the way that stocks are.Bond ETFs eliminate these disadvantages. They are traded on an exchange andthey have similar liquidity and transparency as stock ETFs. Whereas stock ETFs

will usually be made up of all the stock in a particular index, with bond ETFs thefund will hold a proportion of the bonds in the underlying index. The calculation ofbond prices involves a relationship between the coupon, the rate, the bond qualityand the time before it matures. The fund managers use these factors and a samplingtechnique which enables them to replicate the performance of the underlyingindex. With bond ETFs, interest is paid out each month, and capital gains are paidannually. These dividend payments are classed as interest or capital gains for taxpurposes.

Broad-Based Bond ETFs

There are also broad-based bond ETFs that are similar to the broad-based stock


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ETFs outlined above. These ETFs contain a mixture of government and corporatebonds at various stages of maturity. Broad-based bond ETFs are usually considereda fundamental part of a bond portfolio. The iShares Lehman Aggregate Bond is anexample of a broad-based bond ETF.

Yield Curve Bond ETFs

Another option for investors is to purchase Treasury bonds at different maturitystages of the yield curve. Investors will generally use short-term bond ETFs as aplace to secure their money to earn a good return, while the long-term bond ETFsare typically used to speculate on fluctuations in interest rates. Examples ofdifferent yield curve bond ETFs are:

iShares Lehman 1-3 Year Treasury Bond Fund iShares Lehman 3-7 Year Treasury Bond Fund iShares Lehman 7-10 Year Treasury Bond Fund iShares Lehman 10-20 Year Treasury Bond Fund iShares Lehman 20+ Year Treasury Bond Fund

Inflation Protected Bond ETFs

Treasury Inflation Protected Securities (or TIPS for short) are linked to inflation inthat the interest that they pay is equal to the Consumer Price Index (CPI) plus a

predetermined amount. These funds are designed to guard against inflation andwill generally perform better than regular bonds when a rise in inflation isexpected. The iShares Lehman TIPS Bond Fund is an example of this type ofETF.

Asset Allocation ETFs

Asset allocation ETFs are relatively new offerings for a lot of mutual fundcompanies. These ETFs involve investing in a range of different asset classes so

that investors can get a fully diversified portfolio after buying only one ETF.Popular asset allocation ETFs include:

PowerShares Autonomic Balanced NFA Global Asset Portfolio PowerShares Autonomic Balanced Growth NFA Global Asset Portfolio

Target Date ETFs

Target date funds (also known as life-cycle funds) have experienced a surge in

popularity in recent years, particularly within the pension plan market. ETFs withthe same features of these funds have also recently been created. These funds are


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identical to balanced asset allocation funds except for one important differenceasthey get nearer to the target date the fund will reduce risks and adopt a moreconservative approach. They do this by selling risky stocks and purchasing moresecure bonds. These funds are primarily used where the investor has a savings goal

that they want to reach at a designated end date. They are commonly used forretirement savings. Investors who invest in target date ETFs do not need to managethe investment at all, they dont need to make any further decisions afterpurchasing the ETF. Three popular target date ETFs currently available are:

TDAX Independence 2010 ETF TDAX Independence 2030 ETF TDAX Independence 2040 ETF

ETF Alternative Investments

Investing in alternative asset classes is a good way to further diversify a portfolioand add to the core components which are usually equity investments and fixedincome. Alternative investments are suitable for both trading and hedging. Severaldifferent ETFs enable investments in foreign currencies or commodities. Anotheroption is using inverse ETFs to profit from a decline in the market.

Currency ETFs

As the name suggests, currency ETFS were introduced to track currencyfluctuations in the exchange market. These ETFs are based on underlying currencyinvestments which come from futures contracts or foreign cash deposits. Where theETF is based on futures the excess cash is usually invested in US Treasure bonds(or other bonds). Any fees and operating expenses are deducted from the interestearned.

There are currently several different types of currency ETFs available. You canpurchase an ETF to track an individual currency or a group of currencies. A

currency ETF is not suitable as a long-term investment option. It is usually betterto purchase foreign stock or bond ETFs if you want to diversify away from USdollar investments. Currency ETFs can be useful for hedging against exposure toforeign currencies. Some popular currency ETFs include:

PowerShares DB U.S. Dollar Bullish Fund (AMEX:UUP) PowerShares DB U.S. Dollar Bearish Fund (AMEX:UDN)

Commodity ETFs

Investing in a commodity ETF is another way to diversify a portfolio because


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commodities are a distinct class of assets compared to stocks and bonds.Commodity investment can also be a way to protect against inflation as it involveshard assets. There are three types of commodity ETFs:

ETFs tracking an individual commodity (for example, gold or oil) ETFs tracking a group of different commodities ETFs tracking a selection of companies that all produce the same

commodity

Commodity ETFs will hold either a future contract to purchase the commodity, orthey will hold the actual commodity. If they purchase a futures contract then therewill be uninvested cash and this is used to buy government bonds. Interest earnedon the bonds is used to pay any expenses incurred by the ETF and to pay

dividends. Examples include:

iShares GSCI Commodity-Indexed Trust ETF (PSE:GSG) PowerShares DB Commodity Index Tracking Fund ETF (PSE:DBC)

Inverse ETFs and Leveraged Inverse ETFs

Inverse ETFs allow investors to put their money against the market. They aredesigned to react in the opposition way to the benchmarks that they are tracking.

For instance, when the S&P 500 increases by 1%, the inverse ETF linked to thatindex would decrease by 1%. If the S&P 500 decreases by 1%, then the inverseETF will increase by 1%. Leverage Inverse ETFs operate in the same way, butwith double the difference. For example, if the S&P 500 decreases by 1%, theleveraged inverse ETF will increase by 2%.

Inverse ETFs use either futures contracts or short positions. Where they use futurescontracts, the excess cash is invested in bonds and the interest this generates isused to cover the costs of the ETF and pay dividends. There are several factors thatsupport the use of inverse ETFs. For example, if an investor has a particular

position that they dont want to sell (due to illiquidity or unrealized profits) then itmay be difficult for them to make a bearish bet. Buying an inverse ETF is one waythat these investors are able to hedge. For many investors this option is preferableto short selling an index. Tax-deferred accounts can be used to purchase inverseETFs, whereas selling stocks short is not permitted due to the possibility that theinvestor will be exposed to unlimited losses. With an inverse ETF an investor canonly lose the ETFs value. Inverse ETF examples include:

ProShares Short QQQ ETF ProShares Short S&P500 ETF


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Leveraged inverse ETF examples include:

ProShares UltraShort QQQ ETF ProShares UltraShort S&P500 ETF

Investment Strategies using ETFs

Using ETFs adds a significant amount of flexibility to the portfolio creationprocess and other investment strategies. The investment strategies vary from thesimple (portfolio diversification) to the very sophisticated (such as complicatedhedging techniques).

Core Holding

Investors might want to consider having ETFs to make up the core holdings oftheir portfolio. This is an easy way to create a diversified portfolio that covers mostasset classes with minimal expense. This is a good starting point from which aninvestor can customize their portfolio by adding other securities or funds.

Asset Allocation

ETFs make asset allocation easy; you could even purchase an ETF that is designed

with asset class diversification in mind. Depending on the investor, an active orpassive approach can be adopted. They can actively rebalance the portfolio to giveadditional weight to the individual assets that are expected to perform the best.Alternatively, they can adopt a passive approach to rebalancing and simply ensurethat there is a strategic mix that will provide good long term returns.

Diversification

Another advantage of ETFs is the broad range of portfolio diversification that they

open up for the investor. With ETFs, an investor can create a portfolio thatincludes all major classes of assets, including equity (both US and foreign), andfixed income. They can also purchase investments that are unrelated to these majorassets, such as commodities, emerging markets, real estate and many more.

Hedging

An investor can also use ETFs for hedging strategies. If an investor expects themarket to decline, then they are able to buy inverse (or leveraged inverse) ETFs tohedge against this. These ETFs increase in value when the market is in decline.

Similarly, when the investor expects there to be a period of inflation, they caninvest in commodities or ETF bonds that are protected against inflation. Investors


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can also hedge any foreign currency risks that they hold with a currency ETF.Investors can also buy a short ETF as a hedging strategy for a specific stock. Thereare many different options for using ETFs for hedging. They may be usedindependently or with the underlying ETF.

Cash Management

Some investors will also use an ETF to equitize cash. This means that they areusing the simplicity of the ETF structure to invest in the market on a short termbasis until they decide what they want to do in the long term. This provides a wayof parking money temporarily that will still generate an income.

Tax-Loss Harvesting

Tax-loss harvesting refers to the process of realizing a capital loss in aninvestment, and then using the funds from the sale of the investment to purchasesimilar stocks. This strategy means that the portfolio remains mostly the same.There is a rule that prevents investors from repurchasing a security that they have

just sold for a loss within 30 days (this is known as the wash-sale rule). ETFs getaround this rule by allowing the investor to buy an ETF that is substantially thesame as the security or fund that they sold. The portfolio remains very similar andthe wash-sale rule is not invoked.

Completion Strategies

ETFs enable an investor to create a well rounded portfolio without necessarilybecoming an expert in each investment area. For example, an investor canpurchase an emerging market index ETF without having to research the emergingmarket area. This increases the exposure that investors have to a broader range ofsectors and asset classes.

Portfolio Transitions

ETFs also allow investors to ensure that their money is always working for themand that it is not dormant in-between investments. If an investor wants to move hisor her assets to a different advisor or fund, then there will usually be a transitionperiod before this occurs. Investing the funds in an ETF during this period meansthat they will continue to generate income.

Copyright 2011 byMark McCracken, All Rights Reserved
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History of Currency Exchange

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