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Exchange-Traded vs. Index Funds

Tried-and-true index funds still rank highest on our list, but exchange-traded funds can add spice to a well-rounded portfolio.

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This story appears in the August 2007 issue of Entrepreneur. Subscribe »

Exchange-traded funds and index funds aren't so different. They are both baskets of stocks that are meant to cover a broad sector or index and managed passively rather than actively. You're tracking the same well-known, 500-stock index whether you invest in the SPDR S&P 500 ETF or buy shares in the Fidelity Spartan 500 index fund.

The index fund business sure ain't chopped liver, but the ETF business has been booming of late. The number of ETFs on the market has skyrocketed this year more than ever, forcing me in recent months to look again at my long-held preference for cheap index funds. And look I did. The result: I don't think I will entirely change my spots, since I continue to believe that index funds are better much of the time. But I will grant that ETFs deserve consideration for certain investors in certain situations.

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