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Mar.13,2011Many people often confuse exchange traded funds with market indices. This is an extremely easy mistake to make. ETFs often are mirror images of an index, but there are some major differences. For one, ETFs merely track other investment products. An ETF can track and mirror an index, but they are two separate entities. For example, an ETF like SPDR is a mirror image of the S&P 500, only it is reduced so that one share of the SPDR is worth 1/10th of the value of the S&P 500.
An ETF can also track other investment products besides indices using the Portfolio Prophet. ETFs were created so that investors could more easily diversify their capital in a safe and inexpensive way. Indices are imaginary portfolios of stocks, while it is possible to buy a share of an index, it is much more expensive than buying a single share of an ETF.
ETFs also differ markedly from mutual funds. Mutual funds are much more tightly managed and as such have many more fees associated with them. An ETF can be comprised of similar products as a mutual fund, but at a much cheaper cost to the investor. ETFs then offer a flexibility that you cannot find in traditional mutual funds.
Another difference between ETFs and mutual funds is that ETFs have a fixed number of shares. When a mutual fund wants to grow, they simply create more shares for their investors. ETF shares are bought and sold very much like stocks are, making ETFs a more fluid investment.
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