| In recent years more and more investors are | | | | of all their shareholders. ETFs, however, are |
| selecting Exchange Traded Funds (ETFs) over | | | | low-cost and do not have such expenses because |
| mutual funds. But what exactly is an ETF, and | | | | they are traded among investors just like stocks. |
| how do they differ from the mutual fund? The | | | | Unlike some mutual funds, ETFs do not have sales |
| two have some similarities such as allowing | | | | loads or require minimum investments; investors |
| investors to diversify their assets among | | | | only have to pay a commission to their brokerage |
| numerous sectors of the market. However, there | | | | firm to trade ETFs. In addition, most popular ETFs |
| are several important distinctions worth noting. | | | | are extremely liquid, as millions of shares are |
| Tax-Efficiency | | | | traded each day. This allows investors to easily |
| If you own a mutual fund, then you have | | | | trade their shares with minimal impact on price. |
| probably experienced a year-end capital gains | | | | Based on this information, you may assume |
| distribution (even if your mutual fund had a | | | | mutual funds are no longer good investment |
| negative return for the year) because trades | | | | options; however, is not that simple. There is no |
| made by the fund sponsor throughout the year | | | | hard and fast rule, but here are some good rules |
| flow to its shareholders. Depending on the size of | | | | of thumb to determine which is right for you: |
| your portfolio, this can create unwanted and | | | | Many mutual fund companies have low |
| unpredictable tax consequences at year-end. | | | | minimums to start (as low as $25), but |
| ETFs, however, do not have capital gains | | | | commissions to trade ETFs make such small |
| distributions because ETF sponsors do not | | | | purchases very cost prohibitive. |
| transact with their shareholders. ETFs are traded | | | | If an investor plans to dollar-cost-average |
| among other investors. Hence, capital gains/losses | | | | (buy a fixed dollar amount every month) or |
| are controlled by the investor making them highly | | | | reinvest dividends, then a mutual fund is a better |
| tax efficient. | | | | option. |
| Liquidity and Transparency | | | | Mutual funds are effective for gaining |
| While mutual funds investors can only buy or sell | | | | exposure to a very specific sector of the market. |
| their shares directly from the fund sponsor and | | | | For instance, it may be more appropriate for an |
| only at the end of each day, ETFs can be traded | | | | investor interested in investing in international high |
| throughout the day just like stocks. Investors not | | | | yield fixed income or a specific country. |
| only can actively trade ETFs, they can also | | | | The growth in ETFs has exploded in recent years, |
| employ the same trading strategies that apply to | | | | and according to estimates by the Financial |
| stocks (limit or stop loss orders, short-sales, and | | | | Research Corp. of Boston, ETF assets will most |
| options). In addition, it's easier to "look under the | | | | likely reach $1.4 trillion by 2011. And while mutual |
| hood" of an ETF, because unlike mutual funds, | | | | funds still remain the dominant investment |
| ETFs report their holdings daily, giving investors | | | | vehicles in individual retirement accounts where |
| up-to-date information. | | | | the bulk of investor assets are held, it is |
| Cost | | | | important to determine which, mutual funds or |
| Mutual fund companies, regardless of size, incur | | | | ETFs, is right for your unique circumstances. |
| significant record-keeping expenses to keep track | | | | |