Thursday, July 9, 2009

How are ETFs Different From Mutual Funds?

Exchange traded funds (ETFs) are similar to mutual funds in that they are registered with the SEC as an investment company, and they pool investor’s money into a basket of securities such as stocks, bonds, and money markets. However, ETF shares are different from mutual funds in that they trade on a stock exchange so they can be purchased during a trading day for a specific price. Thus, the value of an ETF is determined by supply and demand, not net asset value. Additionally, this allows ETFs to be sold short or bought on margin (more on these terms later).

An ETF usually tracks a market index, commodity, or economic sector. The most common ETFs track indexes like the S&P 500, but funds can also be purchased that invest only in gold, or companies based in Shanghai. ETFs are not usually actively managed so their expense ratios are generally lower than that of mutual funds. However, an investor must pay the usual commissions associated with buying and selling individual stocks in order to invest in these securities. Thus, ETFs are most appropriate for long-term investing.

ETFs are becoming more common in the financial planning profession. Speak to a certified financial planner (CFP) who has a fiduciary obligation to do what is in their clients' best interests to learn whether ETFs are an appropriate investment for your portfolio.

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