by Arlene Hauben

Created on: June 07, 2009

Exchange Traded Funds (ETFs) is a nimble investing strategy. ETFs are similar to index funds, but they trade like stocks. Like stocks, ETFs have three-letter ticker symbols. These type of funds have been an investment vehicle since the early 1990s, but more recently, they have become better understood and popular.

What exactly is an ETF? Each fund is constructed as a basket of stocks that represents a specific index, such as the Russell Midcap Growth Index or the Dow Jones Select Dividend Index Fund. Many ETFs concentrate on a particular industry or sector, such as biotechnology, healthcare, or energy. There are ETFs for commodities and gold, bonds, and also for stocks in specific foreign countries.

ETFs can be purchased whenever you want and sold at any time because they are so liquid. The shares of an ETF trade all day long on major stock market exchanges, although ETFs usually trade on the American Stock Exchange. Investors can buy any amount of shares without a minimum requirement. They can be optioned, shorted, hedged, bundled, and more.

ETFs make it easy for an individual investor to diversify, minimizing the risk of single-stock exposure, and cost less than what most similar traditional mutual funds charge. Annual management expenses for ETFs range between 0.1% and 0.65% and are deducted from dividends. Traditional index mutual funds charge from 0.1% to more than 3%.

Placing sector bets
Some international ETFs give you exposure to stocks in countries that you cannot buy on the U.S. exchanges. When India, Russia, Brazil and China were hot places to invest, there were ETFs for that. Let's suppose you like biotech, you can invest in BBI; if you think technology looks promising, you can take a stake in IYW, the Dow Jones US Technology Sector. There are ETFs that mirror the global real estate market, the environmental and agricultural sectors.

Betting on bonds
ETFs let you make bets on just about anything tracked by an index. Opportunities range from an ETF tracking the ultra-broad Lehman Aggregate Bond index to funds focusing on corporate-bond indices, or inflation-protected Treasuries. For example, TIP is the Tips Bond Fund, an inflation protection strategy.

Investing in cash
If you are not sure where to keep cash, there are short-duration bond ETFs instead of money market funds. These investments often pay more than money-market yields. However, ask first about brokerage fess. Although some money market funds make investors pay early withdrawal penalties, brokerage fees to sell your bond ETFs might run even higher. Many people want to park cash in something less risky than stocks, but want a higher return than they can get from a money market. You might also want to look into an ETF that includes laddered bonds, a series of bonds with varying maturities.

Like traditional index funds, ETFs are best used as a long-term investment tool. The best investing strategies for most investors are the simplest ones - filling gaps in their portfolios and replacing higher-fee mutual funds.

None of the ETFs mentioned in this article are recommendations. They are stated as examples only. Bear in mind that all investments come with risk and reward. Timing is crucial, so do your homework.

Last but not least, don't get too infatuated with the low expense ratios, because there's still a price to pay to invest in ETFs - mainly brokerage fees. And there's the rub...which is why you don't want to become an ETF day trader.

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