We are always looking for ways to improve our investment returns and in looking we are constantly in search of that one "perfect" investment that will solve all of our problems. Many investors have latched onto exchange traded funds or ETFs as if they are the investment that can do it all.

Exchange Traded Funds (ETFs) are pooled investments such as stocks whose shares can be bought and sold in the same way as individual stocks. The American Stock Exchange (AMEX) launched the first major ETF in 1993 in the form of SPDRs otherwise known as "spiders". Spiders are an ETF that tracks the S&P 500 index. Since that time, Barclays, State Street Bank and now Vanguard have sponsored ETFs. Investment in SPDRs alone has grown from $3 billion in 1997 to $23 billion in 2000.

Currently, the ETFs available are primarily index-based or passive (non-managed) funds. When ETFs first started getting attention there was much discussion about them meaning the end of the mutual fund industry. ETFs offer some distinct advantages over mutual funds but are definitely not the answer for all investors.

Let's explore some of the similarities and differences between ETFs and mutual funds:

• ETFs are continuously traded, mostly on the AMEX, in a format essentially identical to trading stocks vs. mutual funds that are priced at the end of each day and are purchased at the calculated NAV or Net Asset Value (market value at the end of the day of each asset times the number of shares held).
• There are no restrictions or penalties for short-term trading vs. a mutual fund that may restrict short-term trading by accessing penalties for selling within 60 days.
• They can be purchased through brokers (including via the internet) as mutual funds can be purchased.
• ETF operating expenses are generally lower than those of traditional index mutual funds.
• They can be sold short, are not subject to the up-tick rule (which only allows short sales after a positive price change) vs. mutual funds that usually cannot be sold short.
• They can be purchased on margin as can some mutual funds
• ETFs can be redeemed in kind by large institutions with large transactions (50,000 plus shares) that allows the fund to manage capital gains more efficiently vs. mutual funds which deal directly with individual investors and must maintain cash for redemptions or sell assets to raise cash increasing potential capital gains distributions.
• Individuals buying or selling ETFs will pay a commission vs. individuals buying or selling no-load mutual funds who pay none.
• Individuals buying or selling ETFs may pay a premium or receive a discount to the value of the underlying assets of the fund vs. individuals buying mutual funds will pay the NAV of the underlying assets.

Points to Remember:

• Active traders can use ETFs to efficiently trade baskets of stocks in the same way they trade individual stock.
• Longer-term investors making smaller, periodic investments are better off buying traditional index funds, because these funds can be traded with zero commission.
• Investors with longer time horizons and larger, lump-sum amounts to invest should consider ETFs if they are investing in a taxable account because of the capital gains considerations.
• Investors investing in tax-deferred accounts may be better served purchasing no-load index mutual funds. However, make sure the expenses are lower than the average because there are index funds that have outrageous expenses.

Review your individual objectives, look at your investment alternatives, analyze ETFs vs. mutual funds and make your choice based on what makes sense for your portfolio.