ETFs and Index Funds

ETFs and Index Funds

Here’s a topic that many people wish they knew more about.  That, and whether the new college football playoff system will be better than the BCS.

Exchange Traded Funds (aka ETFs) were introduced in 1993 with the launch of the S&P 500 Depository Receipt (or SPDR).  This was a mutual fund-like investment that pooled investor’s money together to buy a list of stocks dictated by the S&P 500.

The big difference between the SPDR ETF and an S&P 500 index mutual fund was the flexibility in trading offered by the ETF.  Now, instead of buying or selling your mutual fund shares once per day (at the close of the stock market), you could trade an S&P 500 ETF all during the day like a stock.  You could also write options on the ETF, short the ETF (bet on the investment falling instead of rising), or generally trade to your little heart’s desire all day on small rises and falls of the ETF price.  What fun!

I jest.  I don’t really think sitting in front of a computer all day staring at stock market ups and downs is fun.  But for those who do, ETFs are a way to buy more diversified investments than just one stock at a time.

ETFs are supposed to be less expensive than comparable mutual funds.  This is not always true!  ETFs have annual expense ratios just like mutual funds.  And they are NOT always less than their mutual fund counterparts.  For example, the expense ratio of the SPDR ETF is .09%.  Very low indeed!  However, the expense ratio of the Vanguard Index 500 Admiral Shares mutual fund is only .05%.

Also, ETFs trade like a stock and they generate stock trading fees.  This can be anywhere from $7 per trade at some discount brokerages to over $100 per trade at some full-service brokerages.

ETFs started off as simple index investments that traded like a stock.  Now, there are actively managed ETFs and the categories that ETFs cover is staggering.  Want to invest in a many-years-old list of companies trying fight global warming?  There’s an ETF for that.  How about an ETF that only invests in casinos?  Sure, there’s one out there!  A holding that only invests in beef and pork?  There’s an ETF for you!

ETFs get a lot of press because they are interesting and sexy to talk about.  For the average, long-term investor, though, they may not be necessary for your portfolio.

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