For those out of the currently very popular loop, exchange-traded funds are innovative securities with the characteristics of both mutual funds and stocks. Each one typically represents a group of stocks or other investments yet trades at an often low price and can be purchased via your brokerage.
The other day, I read a solid article about ETFs by CNN/Money writer Walter Updegrave. He made many good points, explaining the various advantages of ETF investing and how they can help perfect your portfolio. For example, he pointed out that:
- ETFs offer an easy way to invest in broad indexes. Plunk a few dollars into the Vanguard Total Stock MarketVIPER
(AMEX:VTI), for example, and you'll instantly be invested in tiny chunks of the vast majority of public companies, ranging from obscure, tiny ones to giant software enterprises based in Redmond, Wash. Invest in "Spiders" (AMEX:SPY)or "Cubes" (NASDAQ:QQQQ)and you'll suddenly be the part owner of the entire S&P 500 or the Nasdaq 100, respectively.
- ETFs offer an easy way to round out your portfolio. For example, if your portfolio is full of blue-chip heavyweights and you'd like to own some small-cap companies but aren't confident of your ability to pick good ones, consider snapping up some shares of the iShares Russell 2000
(AMEX:IWM), which tracks a small-cap index. If you want to focus on small caps that may be undervalued, perhaps choose Vanguard Small-Cap Value VIPERs (AMEX:VBR). If you seek international exposure, there are gobs of globally oriented ETFs, such as iShares FTSE/XinhuaChina25 Index Fund (NYSE:FXI). Want dividends? Look at the Dow Jones Select Dividend (NYSE:DVY). Other ETFs permit you to invest in specific industries or sectors. Nifty, eh?
So far, so good. But Mr. Updegrave also made a suggestion that disturbed me. He said: "By allowing you to move in and out of the entire market or specific segments with one quick trade, ETFs are a natural vehicle for market timing. If you believe the stock market is on the verge of major setback, for example, you can instantaneously dump a total stock market ETF or one pegged to the S&P 500 index and move your money to cash."
I've seen such suggestions before and they bother me. I wonder whether we should engage in such market timing. After all, if you think the market is about to plunge, what are the chances that you're right? It may indeed plunge, but perhaps not for another two years. I've read of studies showing that much of the market's annual gains happen on just a few days. If we're guessing our way in and out of the market, there's a good chance that we'll be out on the days when we should have been in.
Still, overall, Mr. Updegrave made some great points, among them that ETFs "are one of those rare examples of a truly innovative product that has the potential to change for the better the way we invest."
Learn more about ETF pros and cons, ETF investment strategies, and how ETFs compare to mutual funds in our ETF Center.
You may also find the following articles of interest:
- Three Things to Know About Your ETF
- The Age of the Exchange-Traded Fund
- ETFs and Falling Fund Fees
- What to Do When ETFs Split
- Playing Commodities With ETFs
Finally, if you're in the market for some outstanding mutual funds, try our Champion Funds newsletter for free -- it's been on a tear since it launched last year, and it can help you zero in on some above-average ETFs, too.
Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article.