Identification

• An exchange traded fund--ETF--is an investment company similar to a mutual funds. Investors own shares in the fund that represent proportional ownership of a portfolio of securities held by the fund. A major difference between mutual funds and ETFs is that mutual fund shares are purchased and redeemed from the mutual fund company and ETF shares are purchased and sold on the stock exchanges through a stock brokerage account.
  
  

Features

• Exchange traded funds track a specific stock index or security price. They have low expenses compared to actively managed mutual funds. ETFs are passive investments and hold the same stocks or securities as a specific index. ETF shares trade on the stock exchanges and can be bought and sold like regular shares of stock. The prices of ETF shares change during the market day to reflect the change in the tracked index. ETFs give investors a diversified investment in stocks, bonds or commodities with a single security--the ETF shares--purchase. Many ETFs have option contracts trading against them, allowing the different option trading strategies to be employed on ETF share values.
  
  

Types

• ETFs are available that track a wide range of asset classes. The Index Universe lists over 1,000 different funds in their database. Popular ETF categories are U.S. stock market indexes; government and corporate bond indexes; commodities such as crude oil, natural gas and precious and industrial metals; international stock markets, both individual country markets and regional funds; and focused market sectors such as renewable energy or consumer goods manufacturers.
  
  

Potential

• The wide range of available ETFs and low costs to buy, sell and own make ETFs suitable for many types of investors. Long-term investors can set up a portfolio of broad-based, low-cost ETFs with a few specialty funds included for special situations. Short-term traders can use ETF shares for day or swing trading. These traders own the ETF shares for a few hours to a few weeks to take advantage of price and market trends.
  
  

Warning

• The biggest danger with ETFs is the ease with which investors can switch between different funds. A temptation exists to chase the current hot fund. This often results in investors buying popular ETF shares just as the fund peaks, selling for a loss when the share price drops and buying the next hot ETF. Investors looking at ETF need specific investment goals and a research plan to find the ETFs that fit those goals.