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Exchange-Traded Funds: What Do You Need to Know?

Brett Cole, RICP®, AIF®, CRP®

Financial & Investment Specialist

We hear a lot about ETFs these days. What are some of the advantages of owning ETFs compared to a typical mutual fund?

ETFs (exchange-traded funds) are baskets of stocks or bonds that trade on an exchange like a stock. Unlike a mutual fund, an ETF can be bought or sold throughout the day, whereas a mutual fund is only priced at the end of each trading day.  ETFs can also be sold short and purchased on margin.  Most ETFs are passively managed and typically track an index or specific sector of the market.  As they are passively managed, their expense ratios are usually less than an actively managed mutual fund in the same category.  Some ETFs tend to have low portfolio turnover and as a result may be more tax efficient compared to a mutual fund.  As the ETF investment product has evolved over the last decade, new offerings have increased the product complexity and, in some cases, may involve the use of leverage to enhance returns.  It’s good advice to beware of the leveraged products as they can be highly speculative and are generally not advised in a long-term investment program.  

If you like the idea of buying an index fund, then using ETFs as an investment vehicle to build an investment portfolio might make sense.  On the other hand, if you believe that a good fund manager can add value (net of expenses) through research and security selection, then it may make more sense to use a traditional mutual fund. Oftentimes, the best portfolio may be some combination of the two.  ETFs can keep overall costs down while providing broad access to the markets through various indexes, while a good fund manager can add value to the portfolio through potentially better performance, lower risk or some other criteria.