At the close of November 2004, the exchange-traded fund industry's coffers were positively brimming with assets. The Investment Company Institute -- the fund industry's research and lobbying arm -- reported a grand total of more than $211 billion in ETFs at that point, an increase of more than 40% since the end of 2003.
Given that precipitous trend line, now seems like an excellent time to review the good news -- and the bad -- about ETFs. Let's start with the good.
For index investors with a chunk of change to plunk down all at once, exchange-traded funds (ETFs) can offer a convenient alternative to plain-vanilla index funds. For starters, these puppies generally run with expense ratios significantly lower than those of rival mutual funds.
The popular SPDR (AMEX: SPY ) ETF, for instance, will ding you just 0.10% a year, while Vanguard 500 (FUND: VFINX ) costs a comparatively whopping 0.18%. And since both funds track the S&P 500 -- and therefore invest in such stalwarts as Microsoft (Nasdaq: MSFT ) , General Electric (NYSE: GE ) , Citigroup (NYSE: C ) , Johnson & Johnson (NYSE: JNJ ) , and Wal-Mart (NYSE: WMT ) -- investing in the cheaper fund seems like a no-brainer, right?
For folks who invest relatively small amounts at regular intervals (i.e., dollar-cost averaging), ETFs make little sense. Because they trade throughout the day like stocks, you have to pony up a brokerage fee each time you trade an ETF. And as you'd expect, those transaction costs can quickly erode any expense-ratio advantage an ETF might have over a traditional mutual fund.
The bottom line: When it comes to investing in ETFs, don't be lured by a seemingly cheap price tag alone.
Next up: ETFs -- Buyer Beware
This article was originally published on Jan. 6, 2005.