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The Pillars of ETF Investing

Exchange-traded funds (ETFs) have been gaining popularity in the investing world, edging out old school competitors and providing a sense of flexibility for average investors feeling hamstrung by the rules associated with mutual funds.

Carmen calls ETFs a “money magnet.” Of every $100 invested in the market in 2008, $9 went into ETFs – that’s more than quadruple what it was in 2001.

Jennifer Lane, CFP and author of The Complete Idiot’s Guide to Protecting Your 401(k) and IRA, loves ETFs. They have many of the same pros as mutual funds, but you can trade them throughout the day (not that she recommends that). ETFs also follow a simple format, don’t have management fees and allow investors to be efficient in tracking indexes of their choice.

There are three main pillars of ETFs: liquidity, rebalancing, and cost. The liquidity aspect, meaning that an investor can get their money in and out of an ETF whenever they want during market hours is a key to their value as investment tools, says CFP Steve Pomeranz. The downside, however, is that like with stocks, ETFs require you to pay commission every time you execute a trade. Those commissions can add up, so be careful not to trade them too much either on your own or with your broker, Pomeranz says.

As a rebalancing tool, ETFs can help you if you built up your asset allocation in mutual funds, says Lane. But unlike mutual funds, ETFs don’t distribute capital gains unless you sell them, which means you don’t have to pay extra to Uncle Sam come tax season.

As for cost, ETFs have fees as low as .09 percent. The low cost, combined with the minute-by-minute liquidity and transparency make them the perfect investment, says Pomeranz.

Steve’s ETF Pick:iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD). The current yield is still over 6%.

Jennifer’s ETF Pick: Vanguard Large-Cap ETF (VV)
Pomeranz and his clients own (LQD)
Lane's clients own (VV)