ETFs aren't for all investors

Hybrid: Exchange-traded funds can fill a "nice niche" for wealthier, long-term investors.

Dollars & Sense

October 28, 2001|By Kristine Henry | Kristine Henry,SUN STAFF

Exchange-traded funds have become a hot item among investors, but financial advisers warn that, despite their prominence, the funds are not necessarily right for everyone.

Called ETFs, the funds are a cross between an individual stock and a mutual fund. They invest in an index, such as the Standard and Poor's 500, the way index mutual funds do. But investors can buy and sell them instantly throughout the day, just as they would stocks.

"ETFs fill a nice niche but for most individual investors, utilizing a no-load indexed mutual fund might be more appropriate and more suitable," said Bryan Thaler, an investment counselor at the money management firm VanSant and Mewshaw in Lutherville.

Some of the most popular ETFs include Spiders, with a ticker symbol of SPY, which track the S&P 500; Cubes, ticker symbol QQQ, which mirror the Nasdaq 100 index; and Diamonds, ticker symbol DIA, which track the Dow Jones industrial average.

Because they are treated as individual stocks, investors must pay a commission every time they buy and sell ETFs. But financial advisers say ETFs can also have lower expense ratios than regular mutual funds.

That means if an investor has a large amount of money to invest, advisers say, an ETF may be a good way to go, especially if the fund is held for the long term. But if someone planned to put a certain amount into an investment every month - known as dollar-cost averaging - the commissions on ETFs would make them a poor choice.

"I'm not a big advocate [of ETFs] because they are directed at short-term investment objectives, and that's not what mutual funds ought to be," said Tom Miltenberger, general principal at Edward Jones Investments in St. Louis. "[Investors] just ought to buy four to six good mutual funds and hold on to them."

ETFs also differ from mutual funds in another way. Mutual fund prices are based on the price of the stock of each individual company in the fund. But the prices for ETFs are based on how much investors are willing to pay for them on any given day.

"If I think the market's going to go up today because the [Federal Reserve] is lowering rates, I can't take advantage of that with an open-ended mutual fund," said Douglas G. Ober, chairman and chief executive of the Baltimore investment company Adams Express Co. "I can do it with exchange-traded funds."

Ober said ETFs are designed for people who want to get in and out of the market in a day and are not meant to be long-term investment vehicles.

"For somebody who is doing a lot of trading and who is really playing the market, if you will, and believes strongly they can call market turns or can divine what the market's going to do over the short term," he said, "then the exchange- traded funds are really a good thing for them."

He added that brokers like ETFs because of the commission they garner.

"I would say they've been hyped by the brokerage industry," Ober said.

Miltenberger said his firm isn't likely to push the product.

"I would be hard pressed to find, for the investors we serve, a time I'd recommend them," he said. "If they are short-term traders, if they like the idea of putting together a portfolio themselves and understand how the index fits, then the expenses are low and they are very liquid and they can sell when they want. If that's the kind of investor they are, [ETFs] certainly fit the bill. That's not the kind of investor we serve."

Advisers say there's not much difference between ETFs and mutual funds when it comes to tax liabilities, although Thaler noted that mutual fund investors can get hit with capital gains taxes on distributions even if they lost money overall. ETFs have no tax impact until they are sold.

For more information on ETFs, Thaler recommends the Web site www.indexfunds.com, which has a section called ETF Zone that offers a variety of information about exchange-traded funds.

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