Exchange Traded Funds (ETFs) Frequently Asked Questions (FAQs) at Nasdaq.com

  1. Why would I buy an ETF when I can get an index mutual fund without a broker?
  2. Do you recommend ETFs to buy?
  3. What are the pros and cons of ETFs?
  4. Do any ETFs try to beat the market?
  5. Do ETFs always pay out the full dividend of all its constituent stocks?
  6. Is it possible ETFs are just a fad?
  7. How can I go short with an ETF?
  8. Why would I try to match the market with an index fund when I can beat it with an outperforming mutual fund?
  9. Are ETFs guaranteed or insured?
  10. Can you give me asset allocation advice?
  11. How do I go about identifying ETFs which are breaking out, breaking down, trending up or trending down?
  12. Are there currency ETFs?
  13. Where and how do I buy ETFs?
  14. What is the difference between ETFs and Closed End Funds?
  15. Are there any Dow Jones Industrials or S&P 500 ETFs?
  16. Is there a hedge fund ETF in the works?
  17. Are ETFs only for stocks?
  18. How can I short an ETF?
  19. How can I find the P/E ratio of the index underlying an ETF?
  20. Can non-US citizens own ETFs?


1. Why would I buy an ETF when I can get an index mutual fund without a broker?
You can certainly buy a mutual fund directly from a fund group at no "load" or sales charge. Annual management fees will typically be higher with a traditional mutual fund and you can only buy or sell at the closing price at the end of the day.
2. Do you recommend ETFs to buy?
Not in the usual sense of the word. Our analysis tools help the investor compare and contrast ETFs to choose an ETF most suitable for their strategy and profile. Our portfolio tool helps decide how much to buy. But a 'star' system of ranking is worthless, in our opinion. ETFs by definition match their market. A possible exception for this are fundamental ETFs which attempt to beat an index by tweaking its definition modestly, but they do not 'stock pick' like most mutual funds. The main task of an investor is not to pick the 'best' ETF but rather to pick the appropriate one. Unsophisticated investors with very long-term horizons should probably stick to basic low-cost total and broad market ETFs, while talented investors may sensibly investigate semi-active funds and do regional and sector overweighting and cyclical trading.
3. What are the pros and cons of ETFs?
Pros of ETFs vs. mutual funds or direct stock investing include lower cost management fees, low fixed transaction costs, flexibility, convenience, low taxes, and instant pricing. Nearly every type of investor will find ETFs more compelling than. Most of the material on pros is in the Basics area accessible from the Home page (or most pages) by clicking on Basics. Some of the features which are pros for most investors become cons for certain others. Fixed transaction costs which are low for investors buying large amounts of ETFs become relatively high for investors buying small amounts at a time. Therefore, any investor buying less than $1,000 of ETFs at a time should consider buying a broad market index fund direct to a mutual fund group like Vanguard to avoid brokerage fees. Likewise, flexibility is good for most investors, but novice investors or investors with poor judgment and discipline.
4. Do any ETFs try to beat the market?
Quite a few fundamental (or intelligent, semi-active) try to beat an index by tweaking its definition. But the result is still a methodical index. This is the subjective, bottom-up stock picking that most 'active' mutual fund managers engage in. A few attempts have been made to create an ETF which allows subjective stock picking. But ETF investors tend to be skeptical of expensive stock picking managers. While no doubt some managers are better than others at stock picking, in practice it is difficult to tell the talented from the merely lucky. And high fees eat into performance quickly.
5. Do ETFs always pay out the full dividend of all its constituent stocks?
Yes, ETFs always collect the full dividend of all constituent stocks and always 'pay out' the dividends to the ETF shareholder. This can be a cash distribution or a reinvestment in the ETFs' underlying index. It comes to the same, because if your ETF reinvests and you need the 2%-3% annual cash stream you can just sell 2%-3% of your annual ETF position to obtain the cash.
6. Is it possible ETFs are just a fad?
This is not likely. As of July 2003 ETF assets in the US topped $155 billion and are still growing in double digits, far faster than traditional mutual funds.
7. How can I go short with an ETF?
In theory, you do it just as you would any stock. You either call or go on-line with your stock broker, and request to short a certain number of shares of a certain ticker. In practice, many ETFs are not available for shorting. Apprarently there is not enough incentive for holders to loan certain ETFs out so that you can "sell" it. No harm in trying.
8. Why would I try to match the market with an index fund when I can beat it with an outperforming mutual fund?
First of all, the question presupposes that a mutual fund that has outperformed a market in the past will continue to do so in the future. Numerous studies by unbiased university researchers have shown clearly that mutual funds with leading performance records are just as likely to underperform than outperform the market several years into the future. Many investors have concluded that they are better off not taking the risk and instead remain happy with guaranteed average market returns of an index fund. Second, actively managed funds inevitably have higher annual management fees and have a worse capital gains tax profile.
9. Are ETFs guaranteed or insured?
There seems to be little risk of abuse of the ETF structure as an investment vehicle. In the US the Securities Exchange Commission thoroughly examines any application to create an ETF, and only large and closely watched firms are allowed in on the creation and redemption process of an ETF certificate. Finally, the same government agency (the Depository Trust Clearing Corporation) that ensures that individual stock certificates end up in the right investor's hands after a trade also ensures the ETF certificates are assigned correctly in a trade. In a decade of trading billions of dollars worth of ETFs, to our knowledge no US investor has ever lost money from fraudulent ETFs. The risk of the underlying asset is quite another matter. Each asset class must be examined separately, and risk profiles of assets may change over time. Stocks are clearly risky, and ones in technology or emerging markets particularly so. Long-term bonds and real estate are also risky in their own way. Short-term investment grade bonds, however, have generally proven quite safe.
10. Can you give me asset allocation advice?
We are not a registered financial adviser, but as financial journalists we do have opinions about what asset classes are well-priced and overpriced and what constitutes a reasonable model portfolio given someone's profile. Many of our opinions and resources are found throughout the site so I can steer you to them. Please write me at will@(this site), where (this site) is etfzone.com with your situation and I will give my free feedback. -Will McClatchy, Founder
11. How do I go about identifying ETFs which are breaking out, breaking down, trending up or trending down?
Big question and big challenge. Breakouts and trends are technical analysis or charting words, and there are many books on this as well as on-line sources. ETFzone believes that it is folly for most investors to try to perform technical analysis or charting to predict short-term trends. The evidence for any benefit at all to charting or technical analysis is dubious, say researchers. That said, a particularly gifted person can always prove the average wrong. Charts are, we believe, quite helpful for long term investing when used in conjunction with fundamental data to discover signs of bargains or bubbles, but not short term breakouts or trends.
12. Are there currency ETFs?
Yes, indeed, Rydex Investment's CurrencyShares line of ETFs track the Euro, English pound, Canadian and Australian dollars and a few others. The funds earn modest short term interest as well. There are a smattering of others. Go to our individual analysis area and search for the individual currency you are seeking for the latest list.
13. Where and how do I buy ETFs?
Buy them as you would any stock, at any brokerage firm.
14. What is the difference between ETFs and Closed End Funds?
Sometimes the two are confused since they both sell on stock exchanges. An ETF follows a designated index or benchmark very closely and can grow or shrink with investor flows. A closed end fund tries to beat a target index by actively selecting individual stocks and may deviate significantly from the index. Closed end funds are closed to new money, so investors buy and sell shares on the open market. ETF management fees tend to be far cheaper.
15. Are there any Dow Jones Industrials or S&P 500 ETFs?
Yes, there are numerous funds that track these and other popular indexes. Remember that Dow Jones and Standard & Poor's maintain their respective indexes, and that fund groups license the indexes so that more than one fund can end up tracking an index.
16. Is there a hedge fund ETF in the works?
There are hedge fund indexes, so there is no reason to believe there would not be an ETF, especially with hedge funds being so popular.
17. Are ETFs only for stocks?
By no means. Any class of asset that has a published index around it and is liquid can be made into an ETF. Bonds, real estate, and gold ETFs are available now.
18. How can I short an ETF?
Just call your broker. Most ETFs advertise that they can be shorted, but often there is no shares offered for shorting.
19. How can I find the P/E ratio of the index underlying an ETF?
Sometimes index providers give out this information on their Web site. Typically the ETF providers gives out P/E ratios of their fund on their Web site as well. That is useful for most purposes.
20. Can non-US citizens own ETFs?
ETFs are available in most developed nations. In the US, anyone who can open a brokerage account and buy stocks will be able to buy ETFs.