Everything You Want to Know About ETFs -- But Didn't Know How to Ask

Just about everyone by now knows that exchange-traded funds, which trade more like stocks than mutual funds, are hot. But does everyone understand what they are exactly?

The current variety of exchange-traded funds may intimidate some investors, but it's only going to get worse.

At the beginning of this year, there were 30 of these tradable funds. Now, you've got about 46, with dozens more on the way.

Barclays Global Investors is in the process of rolling out about 50 such funds, known as ETFs. State Street Global Advisors, which runs the $17.5 billion Spider that tracks the S&P 500, is coming out with eight more ETFs. Nuveen Investments, known for its unit investment trusts, is planning its own line of ETFs. Vanguard is also planning to offer tradable shares of five of its biggest index funds, although McGraw-Hill's recent lawsuit on behalf of its Standard & Poor's unit certainly threatens those plans.

If you're confused by these mutual funds in drag, you should start at the very beginning. When you get a firm grasp on the basics, the nuances will mostly take care of themselves.

To answer the most frequently asked question first: No, these funds are not closed-end funds.

Closed-end funds, which also trade on exchanges, have a fixed number of shares. For that reason, a closed-end fund can trade at a premium or a discount to its net asset value. (The vast majority, however, trade at a discount.)

Exchange-traded funds, on the other hand, are designed to trade close to the net asset value of the underlying portfolio. New shares can be created and redeemed -- not unlike a traditional mutual fund. However, this process happens only in very large increments, usually 50,000 shares, which limits the practice to large institutional investors, market makers and arbitrageurs.

Instead, the average investor is buying and selling shares of these funds in the secondary market, just like a stock, and is not actually investing money in the underlying portfolio. You can buy them from any broker and will have to pay a commission to do so.

The following stories provide a lengthier introduction to these burgeoning investment vehicles.

The Nasdaq 100 Tracking Stock (QQQ Quote - Cramer on QQQ - Stock Picks) came out in early 1999 and piqued everyone's interest.

Two early stories about the QQQ will give you the basic background on these products: How Does the Nasdaq 100 Tracking Stock Work? and Keeping Track of the Nasdaq 100 Tracking Stock.

A few months later, Barclays revealed its plans to launch a family of exchange-traded funds, which led to A Closer Look at Barclays Proposed Exchange Traded Funds.

The popularity of ETFs was so pronounced that by the end of the year it was evident that Exchange-Traded Indices Pose Threat to Mutual Funds. This story will give you a good overview of what happened last year, and covers newer developments that are happening this year.

Barclays finally got around to launching its much-discussed products and a whole story, How to Spice Up Your Portfolio With Barclays' New Index Funds, was needed to list them.

Vanguard also announced its intention to offer its own tradable funds, which resulted in the follow-up called Vanguard to Allow Cost-Free Switch to New Exchange-Traded Index Shares.

In addition, Merrill Lynch has its own lineup of exchange-traded products called HOLDRs. These fixed baskets of 20 stocks, which also trade on the American Stock Exchange, are not mutual funds. But if you want to know more about those, you can read this early story from last year.

Finally, you can also find information about these products on the Amex Web site at www.amex.com. And Barclays has it own site at www.ishares.com.

That should do -- for now.

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