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Are exchange-traded funds right for you?

Created date

October 22nd, 2013
Stock Market
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You have probably heard about exchange-traded funds (ETFs) in recent years, but maybe you re unsure exactly what the so-called ETFs actually are and whether they could be right for your investment portfolio. ETFs are very similar to mutual funds, in that they are made up of a basket of securities, and therefore provide diversification for investors. Tennessee financial planner Jeffrey Voudrie says a key difference between mutual funds and ETFs is that the latter trades on exchanges like stocks they can be bought and sold anytime during the day. That is very important in volatile markets like we experience now because it allows someone to exit early in the day if needed, Voudrie says. Another reason ETFs have gained popularity in recent years is that they tend to come with lower fees than mutual funds. Minnesota portfolio manager Phil Christensen advises investors to take advantage of that perk, but to do their homework because ETF fees do vary, and if you are investing a large sum of money, the difference between 1% and 1.75% in fees can be sizable. Christensen also likes ETFs because they tend to be more tax-efficient. Mutual funds are more likely to distribute gains, and that is a lot less likely in ETFs, Christensen says.

Exposure to different asset classes

Michigan financial advisor Robert Schmansky says ETFs can be a useful tool for investors to get exposure to different asset classes they might not be able to access with mutual funds. If you want to invest in gold and silver, for example, there are ETFs that own exposure to the underlying metals, as opposed to mutual funds, which generally can t be that concentrated, so instead they tend to own the stocks of gold or silver companies, Schmansky says. Of course, ETFs aren t without their drawbacks. Schmansky says investors who are accustomed to mutual funds might be surprised to learn that ETFs are subject to settlement dates, which means your funds might not be available for up to three days after a trade. Let s say you want to sell $10,000 of bonds to rebalance into stocks, Schmansky says. If you re doing an exchange of ETFs, you may be out of market for a few days, and if it goes up 3% or 4%, you would miss that; whereas, with mutual funds, that wouldn t be the case. Another complexity with ETFs, Schmansky says, is that unlike mutual funds, they can trade at a discount or premium to their underlying value. Investors need to be very careful with how much they are paying for ETFs, Schmansky says. It s more of an issue for newer ETFs that don t have the volume because it doesn t get interest; it s only worth what someone will buy it from you for. The good news is that because ETFs are publicly traded, there is plenty of information available for investors to do their homework before buying. Christensen says you can get some basic details on an ETF by searching for its ticker on Bloomberg.com or CNBC.com. And, he says, as with mutual funds, you can also order a prospectus for an ETF you re considering.meghan.streit@erickson.com

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