The Lure of the Exchange Traded Fund

Sep 10, 2013

Why are exchange traded funds (ETFs) growing in popularity?

Financial commentator Greg Heberlein says the ability to buy and sell them at any time during market hours makes them very appealing.

An exchange-traded fund is similar to a mutual fund. 

But mutual funds tote up the value of the stocks in the fund once a day, at the close of trading. If you place a buy or sell order this morning, you won't know the share price you're getting until after the market closes.

Exchange-traded funds, however, are the equivalent of a stock; the value of the fund is determined as the day progresses, and anyone can buy or sell them whenever the market is open.

No-load mutual funds bought directly from the sponsor typically cost about 1.5 percent. ETFs have a advantage there, charging less than ½ percent on average.

The ETF industry sprouted up 20 years ago, but already accounts for $1.5 trillion. Mutual funds represent $9.5 trillion, but the gap is narrowing. 

ETFs are everywhere—roughly 1,500 choices spread across stocks, bonds and commodities. They can reflect a broad market average, or a small niche.

Here are some things to consider:

ETFs containing fewer stocks representing, say, a particular industry or commodity can be extremely volatile, making it difficult to get the best price going in or coming out.

Although the fee to buy an ETF is low, longer-term shareholders beware: If you are making regular deposits to your account, the ETF fee will be much larger.

Say your broker charges $8 per trade. If you buy $10,000 worth at one time, the cost is $8. But if you buy $1,000 a month for 10 months, the cost is $80. That has a negative bent on dividends, too. If you wish to reinvest your ETF dividends, you must invest that cash yourself, incurring another trading fee.

The ability to trade at any time also can work against the long-term holder. 

Absent self-restraint, an investor might be more likely to jump out of the ETF should a sudden downdraft occur. The potential ETF investor needs to ask whether the personal discipline exists and whether trading during a session is that probable.

ETFs are more transparent. You know precisely which stocks are in your ETF. Mutual funds disclose their holdings only every three months.

Investors with a long-term outlook should consider lump-sum investments and shop only for ETFs reflecting major, broad based averages.

As with every financial decision, make sure you understand the fees and risks involved. No investment is risk-free.