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The Spokesman-Review Newspaper
Spokane, Washington  Est. May 19, 1883

It’s time to learn the ABCs of ETFs

Universal Press Syndicate

Consider adding exchange-traded funds (ETFs) to your portfolio. More than $250 billion is already invested in them (which still pales next to the trillions in mutual funds).

Think of ETFs as mutual funds that trade like stocks. Many are index-based. By investing in one, you’re simply putting your confidence in the companies in that index. Here are nicknames and ticker symbols for some ETFs of major indexes: S&P 500 (Spiders, SPY), the Nasdaq 100 (Cubes, QQQ), Total Stock Market (Vipers, VTI), Dow Jones Industrials (Diamonds, DIA), Russell 2000 (iShares Russell 2000, IWM), MCSI Japan Index (WEBS Japan, EWJ).

With very low fees and tax-efficient infrequent trading, ETFs provide diversification among groupings of large businesses. They’re also among the least time-consuming of all investing strategies. If you want to manage some or all of your money passively (not cherry-picking individual stocks), ETFs provide significant advantages.

ETFs can be shorted, optioned and margined. This can be not such a good thing. ETFs are almost too easy, and as a result, they have been used extensively as short-term investments, the complete antithesis of index investing. John Bogle, the father of index investing, likened ETFs to a shotgun in a recent speech, saying, “They can be used for self-defense, or they can be used for suicide.” Trading in and out of ETFs eats up any cost benefit by piling on trading costs. (Trading in and out of any stocks rapidly can also hurt your performance.)

There’s another group of investors for whom ETFs would not be appropriate: those who dollar-cost average, investing small sums systematically to build up a portfolio. Since there are no direct investing plans for ETFs, dollar-cost averaging could rack up significant trading costs. These investors would do better with a no-load, low-expense index mutual fund, or by dollar-cost averaging into individual companies.

Before buying any ETF, read up on it to understand exactly what its holdings and fees are.

There’s more to learn about these interesting beasts. For more on ETFs, head to www.fool.com/etf/etf.htm or www.morningstar.com/Cover/ETF.html.

Ask the Fool

Q: If I don’t have enough money to buy 100 shares of a stock, am I out of luck? — K.F., Bellingham, Wash.

A: It’s tragic that many people put off investing for years, thinking they’re not rich enough to benefit from the stock market. You don’t need to have $1,000 or more before you start investing. You don’t have to buy 100 shares at a time, either. You can buy 17 shares or nine shares — or even fractions of shares, using some services. Consider investing via dividend reinvestment plans (DRIPs), which you can learn about at www.dripcentral.com. Regular brokerages can serve you well, too, as long as you’re not paying more than about 2 percent of your investment in commission fees. That’s a $600 investment, if your commission cost is $12. Learn more at www.broker.fool.com.

My dumbest investment

In 2000 I rolled $10,000 in my IRA from a certificate of deposit into the Reynolds Blue Chip fund. I thought the fund would grow in value, and I would have a little money to live on when I needed it. I turned 80 years old this year and needed the cash. I received $3,363. — A reader, anonymously

The Fool Responds: Ouch. The Reynolds Blue Chip Growth fund has had a volatile past. In 1995 to 1999, it gained 33 percent, 28 percent, 31 percent, 54 percent and 51 percent, respectively. That’s downright amazing. But from 2000 to 2002, it lost, respectively, 32 percent, 29 percent and 37 percent before gaining 42 percent in 2003 and losing 1.43 percent in 2004. If you don’t enjoy roller coaster rides, this fund isn’t for you. Making matters worse, its expense ratio, an annual fee, is above average, at 1.8 percent. That knocks nearly 2 percentage points off the fund’s return. When looking for a good mutual fund, you need to examine the long-term track record and fees, among other things. Get tips on funds at www.fool.com/mutualfunds/mutualfunds.htm.