An Exchange Traded Fund, or ETF, is an investment that mimics the movement of a broad index and trades on the markets just like a stock.  ETFs are similar to mutual funds in that they are diversified among many different holdings, but the similarities pretty much stop there.   ETFs offer many advantages over mutual funds, and over time will probably drive many investors away from them.

Whereas mutual funds have professional management teams that speculate on individual stocks, ETFs simply mimic the stocks within an entire index.  There are a wide array of ETFs that track different things such as: the S&P 500, Nasdaq, large cap stocks, small caps, European indexes, worldwide emerging markets, the energy sector, etc…  The major benefit to holding entire indexes is that it requires no speculation by the management, resulting in extremely low fees compared to mutual funds. 

At first thought, one would think that ETFs would not do as well as mutual funds, because the fund managers spend their entire careers researching stocks, but that’s not the case.  When figuring in the fees you pay, very, very few mutual funds beat the market long term.  Short term, yes, a lot do well, but long term most do worse than the market as those short term high fliers run into turbulence.  I will try to get some published information sometime to prove that only a select few mutual funds beat the market for a significant period of time. 

I do not currently have any ETFs in my portfolio, but after researching them a bit, they are definitely on my buy list when I get some cash freed up.  I know this is a pretty brief introduction to ETFs, but I’ll spend the next few posts further explaining their advantages and why every investor should own them.