EXCHANGE TRADED FUNDS: A COMBO OF FUNDS AND STOCKS

Q: I've heard that exchange traded funds are the way to invest. Any truth to that? And, are they mutual funds or stocks?
-BC from AOL.

As for whether they are mutual funds or stocks, the answer is: They are a hybrid of the two. And, all are index-based having names like Spiders, Diamonds, iShares and Vipers.

What's neat about ETFs is their dual personality: One the one hand they are baskets of securities, just like a mutual fund is; on the other, they trade just like stocks do ----all day long. Mutual funds don't do that. Funds are priced at the end of each business day when the total value of all the securities in a fund's portfolio is tallied up to establish the fund's net asset value (NAV). It's a fund's NAV from the previous day that sets the fund's per share price for the following day.

ETFs, however, trade each day on the American Exchange with their per share price dependent upon supply and demand. That means an ETFs per share price isn't fixed for a day. Nor is the per share price likely to always represent the value of the securities held in its portfolio--sometimes it may be higher, sometimes lower.

What investors seem to like best about ETFs is that they can buy and sell their shares anytime during the day and trade them as they would any other stock shares that trades on an exchange.

The first ETFs were SPDRs. Introduced in 1993, the index they're pegged to is the S & P 500. Today, there are roughly 100 ETFs around---some representing domestic broad-based indices like the S & P 500 or the NASDAQ 100 ; some representing sectors or various industries, like real estate or technology ; others global or international indices like those found in Canadian or South African.

The Investment Company Institute, the trade association for the mutual fund industry, keeps tabs on the lion's share of ETFs around. Their latest figures show that at the end of September, assets in the 92 different domestic and global ETFs that they track totaled $64.35 billion.

But like all investment products, there's more to ETFs then initially meet the eye. For instance:

- Buying and selling ETF shares means paying commissions. Unlike mutual funds, in which a sales charge is incurred once, you'll pay a commission when both buying or selling ETF shares.

- Expenses. Commissions aside, ETFs, like mutual funds, have annual expenses. The good news is that they are considerably lower than those you'll find on funds. According to Morningstar, the annual expense ratio for SPDRs is 0.12 percent; for iShares, 0.09 percent. Annual expense ratios for mutual funds typically range between 1.25 and 2.00 percent.

- Capital gains distributions. While considered more tax efficient than mutual funds, ETFs can and do make dividend and capital-gains distributions.

ETFs also aren't for everyone.

If you're into dollar-cost-averaging ( investing the same amount of money on a regular basis), mutual fund investing will be more cost efficient than an ETFs. The same is true if you like trading your investments.

And then there is the question of risk. Just because an investment represents an index doesn't mean it's free from risk. ETFs like any other investment, aren't risk-free. In fact, the sector or industry-related ETFs may carry more risk than the broad-based ones depending upon market conditions.

To learn more about ETFs, here are three helpful web sites: www.exchangetradedfunds.com; www.ishares.com; and www.morningstar.com.