An exchange traded fund is a security that acts like a mutual fund but trades like a stock. Unlike mutual funds, ETFs trade throughout the day and their price fluctuates accordingly, whereas a mutual fund has its net asset value calculate daily. Because of that, virtually everything that can be done with a stock (such as limit orders or short selling) can be done with an ETF. ETFs also offer lower barriers to entry than mutual funds do and have costs that are as low or lower in most cases, which we will look at shortly.

There are many exchange traded funds equivalents for classic no load index funds, even from the same family. Vanguard’s vaunted Total Stock Market Index Fund (VTSMX) has an ETF equivalent in Vanguard’s Total Stock Market ETF (VTI), for instance. Also, while VTI has a net asset value of $134.38 as of February 24, 2008, VTSMX has a NAV of $32.70, VTI has a minimum investment of a single share vs. the $3,000 ($2,000 in an educational savings account), and VTI has no required minimum for subsequent investments vs. the $100 minimum for subsequent investments in VTSMX. So, for an investor who doesn’t have $3,000 lying around (but does have $200 where they were hoping to find $3,000), VTI is an option where VTSMX wouldn’t be. VTSMX has the standard Vanguard rock bottom expense ratio of .15% (that’s 15 hundredths of one percent), but VTI has the incredibly low expense ratio of .07% (yes, 7 hundredths of one percent). Of course, there’s still the brokerage fee that must be paid to purchase VTI, but the costs are at least competitive with if not superior to those of VTSMX.

So consider ETFs when building your portfolio; for those investors without a large amount to start with or folks interested in the very lowest costs, they may be a worthwhile alternative to mutual funds.