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This Web site contains a compilation of more than a thousand consumer finance  columns written by Tony Novak from the 1980s through 2006, updated and reformatted for maximum usefulness today.  New material was added after 2010.

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Introduction to exchange traded funds

originally posted: 11/22/2006  reposted: 2/18/2011 This post has not been recently reviewed or revised by the author and may be out of date. If you notice an error or are in doubt, please send a new question by email or ask for an update. Email

Q: What are "exchange-traded funds" and why are investment firms pushing them?

A: Exchange Traded Funds (EFTs) are, in a sense, a cross between stocks and mutual funds that take on the best features of each form of investment. EFTs are very popular with wealthy investors but those who are just starting out in an investment savings program do better with mutual funds until they have at lease a few thousand dollars invested. The EFT is actually a fund invested is a pool of securities just like a mutual fund but the transactions are handled just like stocks. The most commonly cited advantage of EFTS is the ability to manage taxes more effectively, but there are other advantages that may be just as important. To address this question fully, it makes sense to consider the advantages and disadvantages of regular mutual funds as well as EFTs: Advantages of Mutual Funds 1) easy diversification 2) ability to purchase in small dollar amounts 3) low management fees – typically 0.4 to 1.5% of assets Disadvantages of Mutual Funds 1) can only be purchased or sold at the end of day prices 2) generate tax liability even if shares are not sold 3) some gains are taxed at higher short term gain rates 4) not all funds are available in all investment accounts or retirement plans Advantages of EFTs 1) easy diversification 2) can be bought and sold anytime – even within the same day 3) lowest management fees – typically less than 0.2% 4) can be held in any brokerage account or retirement plan 5) no taxes are due until shares are sold 6) can be 100% long term capital gains taxed at lower rates Disadvantages of EFTs 1) best results if purchased in larger dollar amounts – the cost per transaction is the same regardless of the size of the purchase. The latest service offered by investment firms for EFTs is the ability to utilize computer-assisted asset allocation at no additional charge. This is the primary reason EFTs have been in the news lately so non-commissioned investment advisers and consumer advocates have been promoting EFTs as the ideal investment choice for many of their clients. Investment brokerage firms like the fact that EFTs are easily traded just like stocks, so investors are not hesitant to buy and sell them more frequently. Just be sure to avoid investment firms that have asset-based charges unless you understand the details and that approach makes sense to you. In most cases, it is not necessary to pay an asset-based fee with EFTs in order to get great service and improved investment results. The cost to buy or sell an EFT is usually $11 but may be lower for active traders.


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