An Exchange Traded Fund (ETF) is an investment company with a portfolio of securities which fit a particular financial category and style, similar to a mutual fund. The major difference is that an ETF is traded on a stock exchange, not sold or repurchased by the fund itself. The price of the ETF is set by the market - the price that someone is willing to pay for your shares, or to sell you their shares, at any given moment. Most ETFs are not managed funds. They are designed to mirror an index or specific category of investments.

ETFs will usually trade close to the value of their portfolio since large investors and investment firms can buy the ETF shares and sell the underlying securities if the ETF price becomes discounted in the marketplace. The reverse can happen if the ETF price gets too high above the underlying securities - buy a portfolio of securities and sell ETF shares.

Advantages of an ETF -

• Diversification.
• Easy to buy or sell immediately on an exchange.
• Easy to match investors objectives and asset allocation.
• Easy to “buy” an index of securities.

Exchange Traded Funds offer a range of investment categories, objectives and styles.

Examples of different ETF categories, objectives, and styles -

• Large-cap stocks.
• Mid-cap stocks.
• Small-cap stocks.
• Multi-cap - a blend of stock capitalization sizes.
• US Government bonds.
• Investment-grade bonds.
• Intermediate-term investment-grade bonds.
• Short-term bonds.
• High-yield bonds (junk bonds).
• International equities - foreign stocks.
• International bonds - foreign bonds.
• Sector - a specific sector of the economy such as - technology, financial, energy...
• Index - the fund matches a market index such as the S&P 500 or Russell 2000.

ETF Management

ETFs are usually not actively managed. They mirror an index or specific investment such as Gold or Treasury Inflation Protected Securities. The investments in the fund are not evaluated by the ETF’s management. A few ‘managed’ ETFs have been launched recently, but it is uncertain how successful they will be.

Expenses

Since ETF portfolios will usually mirror an index and are not actively managed, the management expenses are very low. The expense ratio of ETFs typically range between .20% and .50%, with some as low as .08%.

Commission - sales charge

Investors pay a brokerage commission when buying or selling shares of an ETF. The commission charge is the same as it would be with any stock on an exchange. Today, with discounted stock commissions, the cost to buy or sell an ETF is considerably less than a traditional mutual fund transaction.

Review Chapter 8 Investing for Retirement - Surviving a Financial Tsunami.

Also, see Mutual Funds and Equities.