The world of exchange-traded funds (ETFs) sure has changed a lot. Back in 1993, the first ETFs launched on the American Stock Exchange were the S&P Depositary Receipts (AMEX:SPY), also known as Spiders. They offered investors an alternative way to get into S&P 500 index funds, via a stock-like instrument that could be bought and sold throughout the day in increments as small as a single share -- though you still paid a brokerage commission for each trade. Buy a few Spider shares, and you'd instantly be invested in 500 of America's biggest companies, participating in the exciting growth of the U.S. stock market.
Today, though, ETFs have become hot, hot, hot. Follow them in the news, and you'll regularly see announcements of new offerings. Whereas ETFs previously allowed you to invest just in broad indexes, today they run the gamut of specialties and niches. This is good news for many sophisticated investors (and those who think of themselves as sophisticated investors), but it can spell danger for those who might end up in over their heads. For many of us, a simple S&P 500 index ETF is all we need.
But what's new, you ask? Well, Rydex Investments, for example, is offering ETFs that track foreign currencies. If you're bullish on the euro, you can invest in the CurrencyShares Euro Trust (NYSE:FXE), and similar ETFs exist for the Mexican peso, Swedish krona, Canadian dollar, and more.
Meanwhile, investors can now short the market (i.e., bet against it) via the Short QQQ ProShares (AMEX:PSQ), which short the Nasdaq, and the Short S&P500 ProShares (AMEX:SH), which short the S&P 500.
ETFs also let investors focus on specific sectors, such as oil drilling or retail. But here's a useful caution from Dan Culloton of Morningstar:
"Even though it is the world's largest retailer, Wal-Mart (NYSE:WMT) shows up in the Consumer Staples Select Sector SPDR and the Vanguard Consumer Staples VIPER, alongside the makers of tangible goods like Procter & Gamble. Meanwhile, it's the biggest holding in iShares Dow Jones U.S. Consumer Services, which owns lots of merchants, including Target (NYSE:TGT), Lowe's Companies, and Home Depot. By the way, if you are really keen on having exposure to those two home-improvement retailers, don't buy PowerShares Dynamic Retail. They're not there; they're in PowerShares Dynamic Building & Construction."
You shouldn't expect ETF investing to be simple, once you stray from basic broad indexes. ETFs can make great sense for some investors, but do your research before buying. You can learn more in the Fool's ETF Center. It features info on how ETFs stack up against mutual funds, how to develop an investment strategy with ETFs, what pitfalls to avoid, and how to avoid ETF impostors.
These articles may also be of interest:
- Mutual Funds v ETFs
- Three Things to Know About Your ETF
- Buy the Whole Mall
- The Age of the Exchange-Traded Fund
- ETFs and Falling Fund Fees
This article has been updated by Foolish research associate Katrina Chan and was originally published on July 11, 2006 by Selena Maranjian. Katrina owns no shares of any company mentioned. Selena owns shares of Wal-Mart and Home Depot, both of which are Motley Fool Inside Value recommendations. The Motley Fool has a disclosure policy.
