Traditional open-end mutual funds have long been the staple of many investors' portfolios. Recently, however, an alternative has emerged--exchange-traded funds. While ETFs have been around since the early 1990s, their popularity has soared in recent years, and they are being used by more and more brokers and financial advisors. In addition, ETFs are popping up in company retirement plans.
ETFs, like conventional mutual funds, hold a basket of securities (stocks or bonds). The primary difference is how the investor buys and sells his or her shares. Whereas investors in conventional mutual funds buy their shares from a fund company and sell them back to the fund shop when they want to redeem, investors buying or selling ETF shares must trade with other investors in the market, much as they would do if they want to buy or sell shares of an individual stock. For that reason, individual investors must use a broker when they want to buy and sell ETF shares.
As the name suggests, exchange-traded funds are priced and traded on an exchange (AMEX, NYSE, or Nasdaq) throughout the day just like stocks. In contrast, traditional mutual funds' prices are set once a day (usually 4 p.m. Eastern) and investors must place their orders before that time in order to get that day's price. Also unlike mutual funds, you can do just about anything with ETF shares that you can with a stock, including setting market and limit orders, shorting, and buying on margin.
So, how do you tell whether an ETF or a conventional mutual fund is best for you? Here are some things to consider:
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