What You Need to Know About ETFs

I'm learning more about (and thus writing more about) ETFs every day. So far, here's what I've had to say about them:

• The Basics of ETFs

• ETFs and Index Funds Are Great Investments

• ETFs: Five Smart Strategies

This piece from Kiplinger's adds to these writings by simply explaining what you need to know about ETFs. Their list:

1. Basically, ETFs are mutual funds that trade like stocks. Some copy the returns of broad stock- and bond-market indexes. Others replicate the performance of baskets of stocks in single industries or in niche investments, such as IPOs.

2. ETFs are great for building a portfolio that matches your investment style. For example, you can construct an aggressive portfolio made up solely of stock ETFs. Or if you prefer a balanced approach, you can mix stock and bond funds. You can also use ETFs as an inexpensive way to boost your exposure to, say, fast-growing companies or emerging markets.

3. Standard & Poor's depositary receipts are nicknamed Spiders, and they track a variety of S&P indexes. Vipers are separate share classes of Vanguard's index funds and offer nearly identical returns. Spiders and Vipers generally have lower management expenses than comparable funds, and over time, lower expenses boost returns.

4. Invest regularly? You'll pay for it. Whenever you add to your ETF holdings, you'll pay a commission, ranging from $5 to $25 a trade, at the 11 online brokerages in our latest survey.

5. Obscure ETFs may be costly to trade. ETFs that focus on narrow sectors and industries are often lightly traded. Such relative unpopularity can lead to spreads as wide as 50 cents between the "bid price" a buyer is ready to pay and the "ask price" a seller is ready to accept.

My thoughts on these:

1. Simple concept and explanation.

2. Ok, I'm still interested at this point.

3. Good explanation. So I guess Spiders and Vipers are good after all, huh? ;-) And who doesn't love "lower management expenses than comparable funds, and over time, lower expenses boost returns?"

4. Uh-oh. This is where it starts to fall apart for me a bit. I do invest regularly (every month), so the trading costs would certainly add up for me -- and thus lower my total return.

5. No problem here. I usually stick to the major indices using index funds.

Overall, the jury is still out for me on ETFs and whether or not they provide enough benefits to switch from standard mutual funds (especially given the fact that I regularly invest/buy).

What about you? What are your thoughts on and experiences with ETFs?

Comments

[FInancial Fruition]

Seeing as ETFs are traded like stocks, I would only assume that you could use a program like sharebuilder to regularly invest in ETFs (calculating their fee into this of course!).

[Khyron]

Best way to invest in ETFs is to dump a big piece of cash in all at once. Don't DCA into ETFs or anything resembling a "regular", automatic investment plan, unless the ETFs are in your retirement account such as a 401(k). Even then, ETFs are best used to drop in a chunk of money in one shot. They share the same trading properties as stocks.

[Rich Slick]

You left out one HUGE advantage ETFs* have over mutual funds: The ability to trade options on them.

My favorite strategy is to sell in or slightly out of money calls a few months out.
If you're bold enough you can also short them if you think their value will decline.

*Not all ETFs trade options.

[thc]

Rich Slick nailed one of the advantages that your explanation missed, the other is intra-day trading--you don't get that with mutual funds.

[FMF]

Neither one of those is an "advantage" that I'd regularly need/use as a dollar-cost-averaging buy-and-hold investor.