David John MarottaDavid John Marotta is the President of Marotta Wealth Management, a fee-only financial planning and asset management firm in Charlottesville, Virginia. He is an oft-quoted writer and speaker on financial matters and his weekly financial column can be found at www.eMarotta.com
Host: What is an Exchange Traded Fund?
David Marotta: There is nothing new in investing in the last 50 years except Exchange Traded Funds and they are new. They are like mutual funds but they trade throughout the day like a stock. Normally, a mutual fund is only traded at 4 p.
m. after all of the, everything in those mutual fund is valued then they will buy and sell shares. If you invest a $100 during the day, they wait till 4 p.
, figure out what the fund is worth and then you buy shares into it. An Exchange Traded Fund is traded throughout the day. So, it's a collection of stocks like a mutual fund, but the value goes up and down based upon what the stocks are going up and down and if you want to buy one, there are companies that will put together an Exchange Traded Fund unit and sell it to you. Based upon the net asset value of the underlying resources, they will sale it to you for a very small transaction cost and then, if you want to sell an Exchange Traded Fund, there are companies that will take that and break it apart and sell all the individual stuff. So, Exchange Traded Funds can be created and can be destroyed throughout the entire day and there are companies that will do that. That keeps an Exchange Traded Fund share always trading very close to the net asset value that the underlying assets are having. If the net asset value goes up above what it s trading at, there is someone who will buy them and break them apart from more than their worth and if there is one that goes below what it's trading at, there are companies that will put together one and deliver it for very much close to what it's worth. The other advantage of Exchange Traded Funds is a mutual fund will have capital gains that it will kickoff every year from it's own buying and selling because Exchange Traded Funds are put together and given to the investor. You don t have to pay capital gains on it until you decide to sell it. So, they are very good in taxable accounts because they have good tax management. You don t have to pay capital gains. The other thing is that when the underlying assets change in a mutual fund, they buy and sell and that triggers capital gains. When they change in an Exchange Traded Fund, they give them to some endowment who trades for something else that s very much like it and because it's a like kind exchange, it's not a taxable event. So, that s why they are called Exchange Traded Funds is because they don t kickoff capital gains until you decide to sell them and then they are just your capital gains. They are not a pooled investment s capital gains.