ETF vs.Traditional Mutual Funds

ETF stands for Exchange-traded fund. ETFs are index mutual funds that can be bought and sold like stocks. Unlike mutual funds whose price are set once a day at 4 pm, ETFs are priced the same way stocks are priced with prices fluctuating throughout the day based the laws of supply and demand. EFTs have many of the features of stocks. You can set market limit and stop-loss orders. You can buy them on margin and sell them short. This not to say you should do these things. The same logic that governs why you should not buy on margin with stocks applies to ETFs. The main advatange of ETFs over traditional mutual funds is cost. Generally ETFs have lower expense ratios than mutual funds.

ETFs advantages over Mutual funds.

• Lower expense ratios
• Price set throughout the day. Thereby eliminating the possibility of illegally timed trading.
• Tax advantages from low turnover

Types of ETF	Average Expense Ratio %
U.S. Equity ETF	0.39
International ETF	0.68
Fixed Income ETF	0.17
Traditional Actively Managed U.S. Equity Fund	1.48
Traditional Actively managed International Equity Fund	1.75
Traditional International Index Fund	0.84
Traditional Actively Managed Taxable Fixed income fund	1.13
Traditional Index Taxable Fixed Income Fund	0.49

**Data is as of 10/31/2005 from 2006 Morningstart ETFs 100

The downside to ETFs is that because they are traded liked stocks they are subject to transaction fees. The advantage that ETFs have in lower expense ratios can be negated by active trading of ETFs. Because of this it is often recommended that ETFs be bought in bulk rather building up a position by continually buying shares. Also some ETFs are narrowly focused and as such become volatile for example the iShares MSCI Netherlands Index NYSE:EWN mirrors the Dutch stocket martket index (MSCI). It is has a YTD return of 19.49% contrast this with Internet HOLDRs (HHH) at -(25.37%) YTD.

As for me I recently sold some poor performing stocks (held less than a year) and bought an ETF that tracks GOLD. I believe that the USD is going to continue to lose value against other currencies. This is a discussion for another time. If you are looking for a cost efficient alternative to mutual funds now is the time to consider buying an ETF. For starters compare iShares S&P 500 to mutual funds that track the S&P 500.