August 15, 2022
Wall Street isn’t great at celebrating milestones (it’s too busy for that). But there is one date that certainly changed the markets in a dramatic way. On Jan. 23, 1993 State Street Global Advisors launched the first ETF when the S&P 500 SPDR (Tii:SPY) began trading.
ETF is short for exchange-traded funds and while it can be argued whether SPDR was the first, it’s impossible to underestimate the impact ETFs have had on investing. From its humble beginnings, SPDR now has more than $374 billion in assets under management and its shares are trading at a price around $423.
ETFs are an enormous part of the market and many retail investors hold shares in them. While it started with SPDR, which tracks shares in the S&P 500, they now represent everything from broad market indices to individual market sectors to alternative asset classes like commodities, real estate, and foreign currency. Individual investors can find ETFs for just about any interest they might have.
ETFs are funds that pool the money of a group of investors to buy a collection of securities. The collection can include a small number of stocks, bonds or commodities or hundreds of pooled securities. For example, the iShares Russell 2000 (Tii:IWM) tracks the Russell 2000 small-cap index while sector EFTs track sectors like biotechnology (Tii:BBH). Other ETFs track commodity markets like crude oil (Tii:USO) or even the stock indexes in foreign countries like Japan (Tii:EWJ) or China (Tii:MCHI).
They might sound a lot alike, but don’t confuse ETFs for mutual funds. While they are both collections of securities that groups of individual investors buy and sell, there are some major differences. Mutual funds are almost always actively managed by a fund manager. Most ETFs are not actively managed, though a handful are. They trade differently as well. Like stocks, ETFs are traded throughout the day while mutual funds are bought and sold just once per day with the price of the fund set a single time every 24 hours based on its net asset value or NAV at the end of the trading day.
ETFs act more like an individual stock when it comes to dividend payments, reinvestments, and other benefits of owning shares, even though the ETF investor does not own the underlying assets.
Technology made ETFs possible and has led to their stunning growth over the last three decades. They are as easy to trade as stocks and generally are priced low enough that the average individual investor can afford them.
And they give the retail investor a chance to diversify without having to buy a bunch of individual stocks. Diversification is a risk management strategy designed to lessen the effects of market volatility and create balance within a portfolio by spreading out investments across different or unrelated asset classes and industries. ETFs can help with diversification because they contain a basket of securities not just one.
It is important to note that even though ETFs are naturally diversified since each share is made up of a blend of securities, they might not be as diverse by sector. For example, if you hold ETFs that track stock indexes from a sector – say biotech -- and that sector tanks, your investment could decline along with it.
Individual investors must also be careful when choosing ETFs. Since they are so popular, many ETF funds have been created. That means the trading volume can be especially low for some of them, which can make it difficult to buy and sell shares. According to Investopedia, concerns have surfaced about the influence of ETFs on the market and whether demand for these funds can inflate stock values and create fragile bubbles. Some ETFs rely on portfolio models that are untested in different market conditions and can lead to extreme inflows and outflows from the funds, which have a negative impact on market stability. Since the financial crisis, ETFs have played major roles in market flash-crashes and instability. Problems with ETFs were significant factors in the flash crashes and market declines in May 2010, August 2015, and February 2018.
When picking ETFs, retail investors should also watch costs associated with them. These expense ratios include administrative and overhead costs that are generally covered by investors. Though generally small (and shrinking as ETFs become more widespread), they are worth looking at before you invest.
ETFs have come a long way from Spider in 1993. There are now nearly 8,000 exchange-traded funds worldwide with almost $8 trillion in assets. Global ETF assets are poised to more than double, to $12 trillion, by the end of 2023, according to BlackRock. “Extending ETFs’ annual organic growth rate 10 years into the future, a time frame with an inherently higher margin of error, points to assets topping $20 trillion, and possibly reaching $25 trillion, by the end of 2027,” according to the asset management firm.
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