Exchange Traded Funds

Buy and sell baskets of stocks with the ETF.

Exchange traded funds (or ETFs) are investment hybrid vehicles that trade like stocks but act like mutual funds.  When you buy into an ETF, you buy shares of a basket of stocks held by the ETF company, with the share price determined by the ups and downs of the entire basket.   Just like a stock, you can buy and sell shares in exchange traded funds any time, in addition to fancy maneuvers like short selling or options trading.   

The ETF is based on the sad fact (for finance majors) that the return on a fixed, broad basket of stocks will likely beat the performance of a money manager over the long term.   It’s the same idea behind the hugely popular mutual funds called index funds. So why would you choose exchange traded funds over index funds?  Some decision points:  

1. If you’re an active trader who jumps in and out of positions to take advantage of money-making opportunities, ETFs are a good bet.  Mutual fund fees and rules discourage short-term trading.

2. If you’re a passive investor, making regular contributions to a retirement pot, index funds are a good bet.  Unlike ETFs, you don’t pay a commission on a trade to buy more shares

3. In both exchange traded funds and index funds, you pay an annual fee to the investment company, but ETF fees are typically lower. 

Scope out what's available from the biggest ETF seller

Barclays pioneered ETFs under the brand name iShares. Its website is a good place to see a range of ETF offerings and learn how they work.

Find the right ETFs

You can buy a gold ETF, silver ETF, oil ETF, natural gas ETF, China ETF, European drug company ETF, luxury goods makers ETF, in addition to broad based vehicles like S&P 500 ETFs that track 500 big US companies.

Check exchange traded funds fees - and compare to index funds

Exchange traded fund fees (or "expense ratios") should be cheap since they aren't paying big trading commission bills or big money manager salaries. ETF fees can go down to 0.15% or $15 for every $10,000 invested. But some ETFs charge far more than that, so take a close look. And the index funds are fighting back: Fidelity's Spartan 500 Index Fund charges 0.10%.

Start trading ETFs

You can only buy ETFs through stockbrokers, so you'll need an account with a brokerage firm to get started. Online brokerages make it easy to find ETF trading symbols, see current performance and trade. Bid and ask prices on ETFs can vary by a few dollars so select "limit order" when you buy and sell to make sure you get the price you expect.
  • ETFs may make good sense for your taxes. You don't owe capital gains till you sell shares of an ETF while mutual funds periodically stick you with capital gains charges for accumulated sales of stocks.
  • If you're used to investing through mutual funds, be aware that ETF funds don't automatically reinvest dividends, as do mutual funds. Ask your brokerage to reinvest without trading fees.
  • Sorry, 401 (k) investors, those workplace retirement savings vehicles aren't likely to offer exchange traded funds because they typically don't allow trading.