The Individual Investor's Guide to Exchange-Traded Funds 2010
Exchange-traded funds (ETFs) continue to grow in popularity. There are now approximately 330 ETFs that each manage more than $200 million in assets. To put this number into perspective, five years ago, many of these funds didn’t even exist.
It’s easy to understand why ETFs have grown so rapidly. Exchange-traded funds trade like stocks. This means they can be bought and sold throughout the day and their prices are constantly updated. ETFs are also popular because of their low expenses. Since they track an index, ETFs tend to be more tax efficient than most mutual funds and have lower expense ratios. Finally, information on their holdings is updated frequently, which provides greater transparency.
Like any investment, exchange-traded funds are not without their risks. Similar-sounding funds can have very different compositions. The top holdings for some funds can account for a very large proportion of total holdings, lowering the diversification benefits. Volatile market conditions can cause large fluctuations in prices. Dividends, when paid, are taxable. Thus, it is important to read the prospectus and stay abreast of the how the fund is managed.
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