Happy Birthday, ETF

Categories : Financial, News
February 8, 2023

Acronyms are all the rage in Washington, D.C., where “alphabet agencies” abound, politicians become famous (infamous?) using their initials (AOC, JFK, etc.), and significant legislation is deceptively named, and then assigned gobbledygook acronyms. On Wall Street, acronyms are used to simplify concepts that are meaningful, if complex. One such acronym is ETF, which is short for Exchange-Traded Fund. Recently, the ETF celebrated its 30th birthday, having been launched by the American Stock Exchange on January 29, 1993.

In order to illustrate the importance of the ETF, a little history is useful. Wall Street was named for a wooden wall constructed in 1652 by Dutch settlers in New Amsterdam (Manhattan Island today), who were defending their territory against an expected invasion by England. The wall was demolished in 1699. Notable events from the area formerly protected by the wall include the drafting of our Bill of Rights in 1788 (by George Washington), while New York City was still the Capital of the United States.

In 1791, securities traders first met under a Buttonwood tree on Wall Street. As the business grew, the Buttonwood traders organized and formed the New York Stock Exchange, where individual securities were bought and sold. Over time, more Exchanges popped up, and the Securities business boomed (on and off, anyway; research the Crash of 1929).

Individual stocks were expensive to buy and sell, and access to most Americans was effectively denied, due to excessive trading costs. In 1744, Netherlands native Abraham van Ketwich created the first pool of securities designed to allow access to the masses, and the mutual fund was born. Throughout centuries, stock trading and mutual fund investing grew into the powerhouse capital generator that drives our economy today.

Mutual funds, for all their contributions to wealth creation, have inherent drawbacks. Internal expenses are relatively large, and tax complications arise from the Tax Code’s treatment of dividends and capital gains within mutual funds. Trades are performed only after regular Stock Exchange hours, and all trades are to and from the Fund Company itself. Recognizing flaws in the system, 70+-year-old Nate Most set out to revolutionize stock and bond trading in 1987. He succeeded in 1993, 30 years ago, and never looked back.

So was born the Exchange-Traded Fund, or ETF, which addressed all the shortcomings of mutual funds. Internal fees, as well as trading costs, were dramatically reduced, the tax treatment is fair and controllable, and trading is done electronically during Exchange hours. And the rest, as they say, is history. Next week we will explore the beneficial intrinsic attributes of the ETF.

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