ETF is the acronym for Exchange Traded Funds.  Simply, ETFs are mutual funds that are traded on exchanges just like stocks.  In other words they can be traded intra-day, which means at any time of the day when the markets are open.

ETFs are different from regular mutual funds in this respect.  Regular “open-end mutual funds” are bought and sold only at a closing price calculated at the end of each trading day.

There are two basic types of ETFs, Index ETFs and Managed ETFs.  Index ETFs are designed to track a specific index, such as the S&P 500, the NASDAQ, the Russell 2000, the EAFE and so on.  Some providers have dwesigned their own indexes.  A managed ETF is more like a managed mutual fund or a “closed-end fund” in that a manager or managers will change the makeup of the fund on an ongoing basis and are not limited to the holdings of a particular index.

ETFs have developed to a level of sophistication that allows investors to invest in virtually any part of the world, in most sectors and at a variety of company sizes and investment styles.  There are broad index ETFs that invest in multiple countries or global sectors.  Others focus on individual countries or sectors within the U.S. markets.  Some ETFs are style oriented, allowing investors to choose between a “growth” style and a “value” style.  Investment jargon will describe as a “blend” style a fund that combines a broad index or specifically trys to include both growth and value styles.

ETFs offer specific advantages over traditional open-end mutual funds and individual stocks and bonds.  ETFs offer two main advantages over traditional mutual funds.  First, they can be traded intra-day, which allows investors to choose their time and, with “limit orders”, select a price at which they are willing to buy or sell..  The second advantage is that they tend to have lower expenses, especially the index ETFs.  The main advantage over stocks is that ETFs offer a more diversified investment, thereby spreading out risk.  For example, if you want to invest in Internet companies with $5,000, you might be able to afford to buy one or two Internet companies at an efficient transaction cost.  With an ETF, you can invest in the sector and simultaneously own a large number of stocks.

You can buy and sell ETFs within most brokerage accounts.  Brokerage firms usually charge a “transaction fee” or commission for each trade, so you need to be aware of these costs if you plan to be an active trader.

Copyright 2008, J. Andre Weisbrod.  All rights reserved.  Any paper or electronic publication, production or other use of this article in any form is prohibited without express written permission of the author.