Some investors in any one of a dozen iShares exchange-traded funds (ETFs) probably received a shock to the system last week when they checked their portfolios before heading off to (or perhaps while multitasking at) work: Their investments in such ETFs as iSharesRussell 2000 Index (IWM) and the shop's S&P MidCap 400 Index (AMEX:IJH) fund seemed to have taken a nosedive, with the value of each cut in half in just a single day.
Not to worry
The apparent precipitous decline of these funds and 10 others, however, was precisely that: apparent. In fact -- and in an important illustration of a major difference between traditional index funds and ETFs -- iShares, a division of Barclays (NYSE:BCS), simply decided to split a clutch of its offerings.
In the case of the S&P MidCap 400 ETF, for example, the shop conducted a 2-for-1 split. As a result, if you held that fund's shares as of the "record date" (in this case, June 6) -- or on or before the "payable date" (June 8) -- you were due twice as many shares on the "due bill redemption date" (June 13), but their per-share value was halved.
Adding to the potential confusion, the fund, along with all the others that were affected, began trading at split-adjusted prices on the "ex-date," which was June 9.
Got all that? Good -- now forget it.
As with stock splits, this is essentially a nonevent. The economic impact is zero, zilch, nada. Indeed, if you're a shareholder in any of the affected ETFs, the only action you need to take is updating your portfolio to account for the split. Otherwise, it'll appear as though your investment has fallen off a cliff.
So why bother splitting?
Good question. Splits are largely cosmetic in nature, having the effect of making a stock (or in this case, an ETF) appear more attractively priced. In fact, though, the underlying value of the security remains exactly the same. Think of it in terms of money. If you have two tens or a single $20 bill in your wallet, you have exactly the same amount of purchasing power, right?
Right.
That logic, however, doesn't prevent some investors from diving in after splits on the mistaken assumption that they've found a bargain -- or in hopes that the security will trade up owing to the psychological impact of a lower price.
Even in the relatively buttoned-down world of ETFs -- a world we explore regularly in the Fool's Champion Funds newsletter service -- this dynamic can potentially affect price. Because they're bought and sold throughout the day like stocks, ETFs can trade at a discount or premium to the underlying value of the indexes they track.
Big kahunas
Not so with traditional index mutual funds, which I count as an important point in their favor. What you see with such big kahunas as Vanguard Total Stock Market (FUND:VTSMX) or Fidelity Spartan 500 Index (FUND:FSMKX), which track the MSCI U.S. Broad Market Index and S&P 500, respectively, is what you get.
To be sure, ETF premiums and discounts are typically quite modest, and there are certainly plenty of worthwhile options to be cherry-picked from the ETF tree. Indeed, our Champion Funds model portfolios -- each of which is just a risk-free trial away -- includes at least one ETF. And such popular picks as Spiders (AMEX:SPY), Diamonds (AMEX:DIA), and Cubes (NASDAQ:QQQQ) offer quick and cheap exposure to the S&P, the Dow, and the Nasdaq 100, respectively.
Trouble is, the stock-like characteristics of ETFs have their drawbacks, too. For starters, you'll have to pay a commission each time you trade in them, and -- while I'm certain that this caveat doesn't apply to the likes of you, Fool -- for some investors, the temptation to trade quickly in and out of ETFs can prove irresistible.
Such market timing is almost always a losing proposition, and considering the fees you'll have to pay each time you buy and sell, quite a costly one at that.
The Foolish bottom line
Given the hybrid nature of exchange-traded funds -- they're part stock, part mutual fund -- prospective investors should weigh ETF pros and cons against those of traditional index funds. And while they're weighing, they should throw an actively managed fund or two on the scale as well.
Indeed, for reasons I explain here, owning both fund flavors makes smart asset-allocation sense -- at least, that is, if the funds you pick are Championship material.
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Interested in ETFs? Make a quick visit to the Fool's ETF Center today.
Shannon Zimmerman, editor and analyst for Motley Fool Champion Funds , owns shares of Vanguard Total Stock Market. The Motley Fool is investors writing for investors . The Foolhas a strict disclosure policy.
