According to the ICI, at the end of 2012 investors had about $1.34 trillion
parked in exchange-traded funds, often called ETFs. ETF assets equate to
barely more than 10% of the value of traditional mutual funds, but these
types of investments continue to grow in popularity. ETF assets have more
than tripled since 2006, while the number of ETFs on the market rose to
1,239 in 2012, up from 359 at the end of 2006.
ETFs operate much like mutual funds in that they commingle the
resources of many investors to purchase a basket of stocks, bonds, or both.
However, ETFs differ from traditional mutual funds in a few important
Trading on exchanges. As the name suggests, these funds trade on the
same exchanges as stocks. ETF prices change from second to second,
just like stock prices.
Mostly index funds. While a few ETF managers actively manage their
funds in an attempt to top benchmarks, the bulk of them track indexes.
Greater transparency. Unlike traditional mutual funds—which the
SEC requires to disclose their holdings quarterly—ETFs must disclose
daily. Of course, since indexes don’t change their holdings often, most
ETFs don’t either.
Convenient trading. Unlike the way mutual funds reprice at the
end of the day and trade only at that price during the following day,
ETF prices rise and fall intraday like stocks.
Hedging. Investors can buy and sell options on ETFs, just as they
can on most stocks. Beginning investors should probably avoid
options, but the freedom to buy and sell options that ETFs allow has
contributed to their popularity.
Trading costs. Many brokers charge more to trade mutual funds
than stocks. When investors buy or sell exchange-traded mutual
funds, they pay the same commissions charged for stock trades.
Fund expenses. Remember that every mutual fund charges fees.
However, because ETFs trade like stocks, investors frequently treat
them like stocks and forget about those fees. And ETFs rarely draw
much attention to the fees they collect.
Selection. Most ETFs track indexes, meaning they’re passively
managed. While some ETFs use active managers, investors seeking
active management will find few options among ETFs.
Perceived complexity. While ETFs look like mutual funds in most
respects, many investors shy away from them. A 2010 study by
Mintel Comperemedia, a consulting firm, revealed that nearly 60%
of investors chose not to purchase ETFs because they didn’t
understand how they worked.
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