For a while, exchange-traded funds (ETFs) were the hot new investment. If you’re new to investing, you may not know what ETFs are. How can you decide whether ETFs will meet your investing needs?
An exchange-traded fund is a mutual fund that’s traded like a stock — that is, throughout the day, in real time, during regular stock market operating hours. When you buy or sell a regular mutual fund, the mutual fund company uses the price at the end of the trading day.
ETFs became particularly popular after the mutual fund scandal of the early 2000s, when mutual fund insiders traded mutual funds outside of the designated times and broke the law doing it. Many investors moved away from mutual funds after the scandal.
Authors Tom Lydon and John F. Wasik thoroughly describe this history and the rise of ETFs in their new book, “iMoney: Profitable ETF Strategies for Every Investor” (FT Press).
Wasik explains: “Tom Lydon and I decided there really wasn’t a decent book out there that had a user-friendly approach, and a lot of them focused on market timing. We wanted to do a down-to-earth look for the average investor. ETFs are really taking off.”
Lydon, a longtime investment advisor who runs an ETF Web site (ETFTrends.com), and Wasik (johnwasik.com), a financial journalist for Bloomberg News, provide ETF investing basics in “iMoney,” including how ETFs were developed, and describe ETFs in a variety of sectors, including commodities, currencies and foreign stock.
But some of the ETF material reads as though it could be applied to any type of investment in one of those sectors. Certain sectors, such as commodities, may be volatile regardless of the type of investment you choose, whether a stock, a mutual fund or an ETF.
While Lydon and Wasik offer comprehensive ETF information, this book is not for beginner investors. Beginners should read a more basic investing book first.
“We assume that people would have some knowledge of investing,” Wasik says. The reader “was probably in mutual funds, has done a lot of trading in the past couple of years and was burned by mutual funds and market timing.”
Wasik says he and Lydon “also assume there will be people out there who want to play the market,” so they provide a couple of strategies for them.
The first ETFs that fund companies introduced were index funds. These days, you can buy specialized subsector ETFs, such as HealthShares specializing in cancer or endocrine health, as described in “iMoney.” The narrower the scope an ETF has, the riskier the investment it is.
The authors do a good job of explaining the risk involved with more specialized ETFs and how they differ from index funds. They also clearly describe how indexing works and which indexes fund companies use for index ETFs. Because major indexes such as the Standard and Poor’s 500 include a variety of companies in different sectors, such an index ETF is diversified and thus reduces risk.
Do exchange-traded funds have a downside? ETFs are not well suited for dollar-cost averaging, or investing a small amount of money on a regular basis. This is because unlike with most mutual funds, each time you buy an ETF you have to pay a broker’s commission.
“For small amounts it really doesn’t make sense, even if you’re going with a deep-discount broker,” Wasik says. If you’re already familiar with other types of investments, such as stocks, bonds and mutual funds, and you want to learn more about ETFs, read “iMoney: Profitable ETF Strategies for Every Investor.” But it’s not a book to pick up if you’ve never read any other material about investing. It helps to understand concepts such as diversification and risk prior to reading this book on ETFs.
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Oct. 16, 2008.