Exchange-traded funds basics
Exchange-traded funds were introduced in 1993 but have only recently gained widespread acceptance. So what exactly is an exchange-traded fund (ETF) and how do these funds differ from mutual funds? They both represent baskets of stocks or bonds but ETFs tend to represent indexes or market segments and mirror or track these indexes. An ETF is traded on an exchange, like an individual stock. Their prices change throughout the trading day making it easier to buy and sell whenever the exchange is open. Mutual funds, on the other hand, are priced once a day at market close. If the index or sector your ETF tracks does well, so does your ETF. If the index drops, the price of your ETF will also drop.
ETF management fees (MERs) are also much lower than those of mutual funds because their fund managers do very little trading (this is known as "passively managed"). Mutual funds, on the other hand, are actively managed and therefore charge a fee to pay their professional managers for their expertise. In addition, there is never an entrance or exit fee (this is known as a "load") for ETFs as there would be for many mutual funds. Many studies have shown that over time, most active managers fail to
beat their comparable index funds and ETFs because picking
market-beating investments is a very hard thing to do.
With a mutual fund you often have little idea of what stocks the fund manager is holding. If a mutual fund advertises itself as aggressive it may end up changing its focus becoming more conservative over time but not communicate this change to it's investors. ETFs, on the other hand, are completely transparen't and there is always a complete listing of their holdings on their website or in their prospectus.
To find out more about ETFs and whether they are the investment tool for you, check out these books:
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