Fool.com: Funds That Trade Like Stocks [Special]

For years, The Motley Fool's investing advice has centered around one single step: "Get thee to an index fund!" Yes, we write about stocks because we enjoy the chase, the chance of beating the average return of the stock market by selecting equities. But really, given that many people lack the time, inclination, or even the experience to choose stocks, I believe that the first advice we ever gave is still the best.

Index funds may give you an "average" return, but that's actually significantly better than average because the majority of actively managed funds fail to match the indexes. Some of the best thinkers in the investment community, including Vanguard Group founder John Bogle and Berkshire Hathaway(NYSE: BRK.A) Chairman Warren Buffett, are strong proponents of index funds. Buffett had this to say about indexing back in 1993:

That investor should both own a large number of equities and space out his purchases. By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when "dumb" money acknowledges its limitations, it ceases to be dumb.

Ah, but the mutual fund management community caught on to this and rolled out hundreds of their own index funds. There are now several hundred "index" funds, many with expense ratios running as high as 2% per year, compared with the granddaddy of the index funds, the Vanguard 500 Index (VFINX), which charges just 0.18%. These days, index fund investing is filled with traps. But there is a simple way to avoid paying high fees, and that is to buy them in the form of Exchange-Traded Funds, or ETFs, all of which trade on the American Stock Exchange.

ETFs are funds that trade like stocks. More specifically, they are index funds that trade on the open market. They offer a lethal combination of extremely low cost, versatility, and diversification in a package that costs the exact same amount to buy as a normal stock trade. ETFs track nearly every index you can imagine: the S&P 500, the Dow Jones Industrial Average, the Wilshire 4500, bonds, countries, industries, and sectors. Expenses are minimal, and they are generally transparent because they are deducted from dividends payable to investors. What's not to like?

These products are a dream -- for financial service marketers and for most Foolish investors alike. The first ETF, the Spider(AMEX: SPY), was launched in 1993 and currently has more than $32 billion in assets being tracked. But today, there are nearly 100 different forms. To get a complete list, go to the American Stock Exchange website.

The first time I wrote about ETFs for the Fool was in July 2000. At the time, the vast majority of them were less than a year old. I remarked then that investing in an ETF might take 10 minutes per year if you stopped to make a sandwich in the middle. This is still essentially true, though the menu of ETFs has broadened.

Sample ETFs: