Rich Snail

First time here? You may want to read more about Rich Snail or even receive regular updates via a RSS feed reader or by email. Good read!

ETFs will typically work like a normal index fund; they invest in a group of stocks, bonds, and other instruments and mimic the performances of the index tracked. These passive investments were created 15 years ago and enjoyed a rising popularity since their inception. Why is that?

Index fund with stock flexibility

ETFs work like stocks; you can buy and sell them through a brokerage account; they will also be issued detailed information on their security. Like index funds there are many different ETF tracking all sorts of indices. Famous ones are the iShares S&P 500 or the SPDR - based also on the S&P 500.

What does this means for you?

Like index funds, they are considered passive vehicles; for you this means that your expense fees will be relatively low. On average, they will not beat the normal index funds, as they are traded through the day, but should be quite close. Turnover also is quite low as they track indices. This means the fund manager will enjoy lower trade expenses, yours dropping too thanks to the domino effect.

Sounds great – but what are the caveats?

As with normal index funds, you may encounter potential hiccups. What could they be?

Firstly your expense ratio will be slightly higher than with normal index fund. As with every financial product you will need to do your background work and select the ETFs which match your criterias. Unless you are looking for something very specific, you usually can find ETFs with low costs.

Secondly you will need to pay a commission to the brokerage when you buy or sell shares in the ETF. It can quickly add up if you trade on a regular basis or if your buyings are in small number.

Thirdly, the fact that ETFs are working as stocks, you may not enjoy dividends or capital gains reinvested. Some ETFs may be the exception here, so once again, doing your homework can be interesting.

Finally, some ETFs may not be based on good indices. Because of an ill-constructed index you may end up paying more in trading fees as the index keep changing. It may also mean that your ETF end up with low trading and you could end up with a significant bid-offer spread.

At the end of the day…

ETFs are a sound alternative to index funds. They enjoy an interesting trading advantage, while not having too much of a draw-back in term of cost should you go for a good provider. A safe one to start with would be Barclays Global Investors with their isharess products.