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ETF Questions & Answers

| August 17, 2015
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Although exchange-traded funds, commonly known as ETFs, have existed for almost two decades, they’ve only recently caught on with retail investors. The ETF market has evolved, and investors now have hundreds of ETFs from which to choose.  At HCM, we incorporate ETFs in the foundation of each of our portfolios to obtain low-cost market exposure to efficient asset classes. Here are three commonly asked questions concerning ETFs.

Q: What is the difference between the ETF market price and net asset value (NAV), and why do ETFs trade at a premium or discount?

A: An ETF’s NAV is the value of all the fund’s assets divided by the total number of shares. This calculation is done at the close of each trading day and can be affected by changes in the market value of the underlying securities. The market price is the price at which the ETF is trading on the exchange, which can be affected by supply and demand. During times when demand for an ETF exceeds supply, the market price of the ETF is higher than its NAV and the ETF is said to trade at a premium; when supply exceeds demand, the market price of the ETF is lower than its NAV and the ETF is said to trade at a discount. ETFs generally do not trade at persistent large premiums or discounts.

Q: What are the tax advantages of ETFs?

A: Taxable capital gains are realized when a fund buys and sells securities at a profit, which is then passed on to investors. When an ETF buys and sells (creates and redeems) shares, it is usually done in-kind, which means no cash is involved, as ETF shares are exchanged for an equivalent basket of its underlying securities instead. This helps the ETF to minimize realizing and then passing on taxable capital gains to investors. 

Q: What are the costs?

A: Buying and selling some ETFs incurs a brokerage fee.  However, many of the ETFs we use at HCM trade with no brokerage commission.  Like other structured financial products, there are moderate operating costs associated with ETFs.  Generally, the fees to hold an ETF are much less than those related to most mutual funds making them less expensive to own. As with mutual funds, if an investor makes frequent contributions or withdrawals, trading costs can add up and pose a drag on long-term performance. That said, the platform HCM uses offers commission-free trades for many ETFs. When these securities make sense, we use these ETFs to further reduce trading costs.

If you would like to discuss the use of ETFs in your portfolio with your HCM Wealth Advisor, give them a call at 513.598.5120. 

Article content used with permission from Broadridge Investor Communication Solutions, Inc. Copyright 2015

Content in this article is not intended to be financial advice. Instead, we think of it as educational and financial education is important to us.

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