It’s hard to avoid hearing about exchange-traded funds (ETFs) in the financial press, and many investors are excited to start using these versatile investments. Before you dive in though, it’s important to get the facts about ETFs: What they are, variations among them, and when they might be right for you.
What is an ETF?
An exchange-traded fund is essentially an index fund that trades like a stock. There are ETFs covering everything from broad stock indexes to individual commodities, and the number of funds has been growing dramatically in recent years— from fewer than 200 in early 2005 to well over 600 in early 2008.
ETFs come in three varieties There are three major types of ETFs: Traditional, niche and exotic. Traditional ETFs are what most investors have in mind when they think of exchange-traded funds. These are low-cost, tax-efficient funds (most with annual expenses of .35% or less) that provide access to a broad range of securities in an asset class such as large U.S. stocks, small U.S. stocks, international stocks, or investment-grade bonds. Traditional ETFs are useful tools for inexpensively diversifying your portfolio, and they are available in all major asset classes.
“An exchange-traded fund is essentially
an index fund that trades like a stock.”
Niche ETFs are similar to traditional ETFs except that they focus on a narrow slice of a broader asset class. Niche ETFs invest in individual sectors like health care, single countries like France, or narrow parts of the bond market like high-yield bonds. They tend to have somewhat higher expenses than traditional ETFs. Niche ETFs can be useful for completing a well-diversified portfolio, providing access to a part of the market that you’re not getting from your individual security holdings. However, it
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