ETF or ETN?

First, if you’d like a refresher on EFT’s check out our previous blog –

               http://www.regardingyourmoney.com/blog.htm?ID=2906

However, the term ETF is often misused and the subject referred to may not be true “Exchange-Traded Funds”.  Unfortunately, this occurs often, even by those in the financial world who know better.  In this blog, I will attempt to explain a similar but different form called an “Exchange-Traded Note” or ENT.

A bank issues ETNs which are debt notes that pay a pattern of return.  Say you buy an ETN linked to a certain commodity.  If that commodity happens to increase in value, your investment in that ETN increases.  An ETN can be linked to anything – equities, commodities, mixed equities, and bonds, etc.  All types of imaginable products that couldn’t be parceled in an ETF.  Also, an ETN offers long-term tax advantages that most ETFs can’t achieve.

An ETN is linked to a market index and it pays on maturity.  You don’t own the assets, they are unsecured debt obligations.  There are no dividends or interest payments that are taxable; no short-term capital gains.  You will pay long-term capital gains when the ETN is sold.  With an ETF, you pay yearly on the capital gains. The exception to this rule is currency ETNs.  If you are looking long-term, the ETN is the better investment over an ETF due to the tax advantages.

BUT – and it’s a big one! – if the bank that issued the ETN should fail and declare bankruptcy, you lose all of your money.  Some of the Lehman’s investors got caught with their pants down if they didn’t get out of their ETNs in time.  The upside of this issue – banks don’t go bankrupt overnight!  If you are paying attention, you will be able to “redeem” in time. 

Credit risk is readily monitored on web sites such as ETN.com.  If you watch the CDS (cost of credit default swaps) you will be able to protect yourself against a default.  To watch the progress go to the Efficiency tab on the ETN you own or are thinking about and look at the ETN Counterparty Risk.  If it is listed as LOW – you are good to go.  If it reads HIGH – make some moves!

#EFT #ETN #taxadvantage #commodities #indexes #investments #finances #longtermgains #shorttermgains

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