You've probably heard about exchange-traded funds (ETFs), those investment instruments that trade like stocks but frequently track indexes. Read up on them long enough, and you'll also run across HOLDRs. They're often considered to be a kind of ETF, but some sticklers will refer to them only as cousins at best. Both instruments permit you to tap into instant diversification, often for low fees, and both provide some tax advantages over index funds. But before you jump into the world of ETFs, let me shed some light on what makes HOLDRs a little different from your garden-variety ETF.

HOLDRs is an acronym for holding company depositary receipts, and the only ones you'll likely find available are issued by Merrill Lynch (NYSE:MER). HOLDRs were introduced way back in 1998, so they're not exactly venerable devices.

Each of the 17 currently existing HOLDRs represents a group of stocks in a given industry. While ETFs typically track various indexes, such as the S&P 500 or the Vanguard Emerging Markets Index, HOLDRs aim to track an industry or industry niche via a handful of representative companies. Indexes change over time, with some companies being added and others dropped. But HOLDRs are designed not to change. If a stock is removed (such as when a merger occurs), it's not replaced. (That said, since these instruments are so new, these rules may eventually be revised.)

This inflexibility isn't necessarily a good thing. If a HOLDR that started out with 20 companies ends up with just 10, it's much more concentrated, and thus riskier. Consider the Internet HOLDR (AMEX:HHH). It currently sports just 12 companies, and the top two, eBay (NASDAQ:EBAY) and Yahoo! (NASDAQ:YHOO), make up more than 50% of the instrument's value. If one of them crashes, it will take the HOLDR down with it. Meanwhile, four other companies make up a total of just 2.5% of the HOLDR.

Similarly, the Biotech HOLDR (AMEX:BBH) sports 17 companies, but the top holding, Genentech (NYSE:DNA), makes up nearly 40% of it, with Amgen (NASDAQ:AMGN) making up another 25% for a total of nearly two-thirds.

Details, details
Note also that you have to buy HOLDRs in 100-share lots. That's not chump change, especially when many HOLDRs sport prices greater than $100. The Biotech HOLDR, for example, recently traded for around $186 per share, requiring a $18,600 initial investment for a 100-share lot. On the plus side, Merrill Lynch permits you to essentially cancel your ownership in the HOLDR and convert it into shares of each underlying stock. You also get to vote and to receive financial reports from the underlying companies when you own a HOLDR.

The bottom line
Some HOLDRs are currently rather concentrated and risky, overweighted in certain companies. Others are much less so, but they may become more perilous over time, because of industry consolidation. If you're interested in them, read up at

In general, though, I suspect that most of us can do better by sticking with broader indexes, or focusing on various industry niches by selecting companies on our own. Remember that many of these HOLDRs were assembled back in the 1990s, when companies such as Lycos and @Home seemed more like major players in their respective arenas.

Learn much more in our ETF Center. It features info on how ETFs stack up against mutual funds, how to develop an investment strategy with ETFs, pitfalls to avoid, and how to avoid ETF imposters.

These articles may also be of interest:

eBay and Yahoo! are Motley Fool Stock Advisor recommendations. Try David and Tom Gardner's flagship investing advice newsletter free for 30 days.

Longtime Fool contributor Selena Maranjian owns shares of eBay. The Motley Fool has a full disclosure policy.