Funds That Track Indexes and Sectors

Here's the skinny on exchange-traded funds.
This story first appeared in the August 2004 issue of Entrepreneur. To receive the magazine, click here to subscribe.

Turned off by mutual funds but like the idea of investing in a packaged product that's designed to track an index or sector? Consider exchange-traded funds, or ETFs.

ETFs are like an index fund and closed-end fund combo. Each represents a basket of various indices-from ones that track the S&P 500 to international and sector indices-and trade as stocks do, all day long.

What makes ETFs popular, even while requiring investors to pay a commission when buying or selling shares of them? "They're a great low-cost, tax-efficient alternative and now come in a variety of flavors," says Jeff Tjornehoj, a research analyst at Lipper. Unlike mutual funds, ETF annual expense ratios are a fraction of those on open-end funds, typically running less than 1 percent. Plus, they're sans sales charges and 12b-1 fees.

The downsides? ETFs aren't for active day traders or investors who practice dollar-cost averaging. Why? The commissions can take a big bite out of returns, warns Tjornehoj, "even if you're making cheap $8 trades."


Dian Vujovich is an author, syndicated columnist and publisher of fund investing site www.fundfreebies.com.

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