Because they trade like stocks, ETFs give investors more flexibility than regular mutual funds. You can buy and sell them
anytime during the trading day, not just at the market's close, as is the case with the overwhelming majority of mutual funds.
You can sell an ETF short—that is, make a bet that it will decline in price. You can buy ETFs "on margin," in other words,
by borrowing from your broker.
Investors often like ETFs because they can put stop-loss orders under them, just as you can with ordinary stocks. Let's say
you're bullish on cancer research companies but fear getting stuck with too many investments in the sector if it falls too
far. You can buy cancer-company-based ETFs with a stop-loss that instructs your broker to automatically sell the ETFs if they
COMPARING ETFs WITH INDEX MUTUAL FUNDS
You may wonder, Aren't ETFs exactly like index funds? It's a fair question. It's true that that the differences between ETFs
and index funds are not huge. But ETFs have benefits over mutual funds for almost every category important to traders (Table
Table 1. A comparison of exchange-traded funds and mutual funds
How those benefits stack up depends on what type of investor you are. If you've been an index-fund investor for years—particularly
if you've already built up substantial unrealized capital gains—the last thing you want to do is sell your index funds and
buy ETFs. Stick with what you've been doing.
Buying an ETF or a portfolio of ETFs makes the most sense if you have a brokerage account and like the idea of consolidating
your assets in one account. But keep in mind that you pay more than just the rock-bottom expense ratio when you buy and sell
ETFs. You also pay a brokerage commission and the (usually small) difference between the bid–asked spread on the ETF. Investors
putting a substantial sum in an index at one time will likely end up paying less with an ETF. Those investing small amounts,
particularly on a regular basis, will do better with index mutual funds.
For truly long-term investors who plan to hold an index fund for at least ten years, ETFs hold a clear advantage. Why? Because
they rarely pay out taxable capital gains. ETFs' tax efficiency saves mere pennies in taxes when you hold a fund a year, or
even five years. But over longer periods, ETFs may be a better way to shield capital gains from the tax man than IRAs and
other tax-deferred vehicles. That's because when you cash out of IRAs, you're taxed on your gains at your ordinary income-tax
rate, which is much higher than the capital-gains tax rate, unless you have only a tiny income.
So behold the dawn of a new era on Wall Street, and in the life sciences industry. A new, more flexible, more management fee-
and tax-friendly way to invest in biopharm companies has arrived, with no discernable differences in performance than mutual
Where do I sign up?
Celebrity author and business/finance commentator for CNN and Fox News,
Brian O'Connell has written for The Wall Street Journal and Newsweek. He can be reached at 267.880.3144, firstname.lastname@example.org