In the wake of the mutual fund scandals, many investors find themselves in a dilemma. They don’t like the buddy-buddy insider games played by some fund managers, but they lack the time and expertise to research and follow a bundle of stocks each day. So what’s a small investor to do?
For many, the answer is exchange-traded funds. ETFs are stock and bond portfolios that track an index like the NASDAQ, the Russell 2000, the Dow Jones Industrial Average, or less familiar indexes devoted to sectors of the economy like technology, retailing, or energy.
The oldest ETF, called SPDR, follows the S&P 500. You’ve probably seen the “Spiders,” as they’re called, crawling across magazine advertisements. Another very popular ETF, QQQ, tracks the NASDAQ 100.
An ETF is the platypus of the financial world, a hybrid that is traded like an individual stock while providing many benefits of traditional mutual funds. Buying shares in an ETF gets you a broad basket of stocks, thus ensuring some diversification. But while the mutuals’ prices are set once a day after the 4 p.m. market close, ETFs can be traded all day long through individual brokers.
Another big difference: Unlike mutuals, ETFs have no fund manager to make the calls and collect big salaries, which usually means lower annual-expense ratios for them. However, you do have to pay brokerage fees when buying or selling shares of an ETF, just as you do for shares of Dell or FedEx.
Needless to say, ETFs are no sure thing; do your homework before investing. A good place to start is the website of the American Stock Exchange (www.amex.com). TD Asset Management (www.tdam.com) also has a good primer on ETFs.