As investors become more savvy, many of them are watching things like fees and expenses. The average small-cap mutual fund has an expense ratio over 1 percent, according to Morningstar. Even the expense ratio for the average large-cap fund is almost 1 percent. Yet, investing in individual stocks takes more time and money than the average investor has. Fortunately, there are other investment options, like the ETF SPY.
Exchange traded funds, or ETFs, are similar to mutual funds in that they are also a collection of stocks bundled together as a single investment. However, unlike mutual funds, ETFs are passively managed. That means that the company running the ETF does not spend money researching and buying and selling stocks. Rather, the ETF is typically constructed to mimic the performance of an underlying index. Also, unlike mutual funds, ETFs are not bought and sold through the managing company. Instead, ETFs are traded on the open markets just like individual stocks.
One of the best known ETFs is called "Spiders." The name comes from the approximate sound of pronouncing the acronym for Standard & Poor's Depositary Receipts. SPDRs are exchange traded funds that represent ownership in the SPDR Trust, which is itself a unit investment trust, or UIT. SPDRs trade under the ticker symbol SPY and are occasionally known by that name as well.
SPY seeks to track the price and yield of the S&P 500 Index. The underlying trust buys shares in a basket of stocks that make up the companies in the S&P 500 Index. This is the only investment the fund makes. Therefore, taxes from buying and selling stocks at a profit, known as capital gains, are very low. Additionally, since the only income generated by the fund comes from the dividends of companies in the S&P 500, virtually all income produced by the fund is taxed at the 15 percent tax rate for qualified dividends.
Although the SPDR ETF is designed to closely track the performance of the S&P 500 Index, the fund does not buy shares in all 500 companies in the same amounts that they exist in the index. Instead, SPY shares are invested in a representative bucket that is constructed to provide similar returns without the need to actually purchase shares of all 500 companies.
The expenses associated with owning SPY shares is far lower than traditional mutual funds. The expense ration for SPY shares is just 0.10 percent. However, there can be other expenses you must take into account. Since SPY is traded on the exchange like any other stock, buying shares usually incurs the same brokerage commission that buying stocks does. You must account for this expense on both buying and selling shares.
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