* ETF basics: Similar to a mutual fund, an ETF is a basket of stocks or bonds that comprise a fund. Identified by intriguing names such as “Spiders,” “Diamonds,” and “Cubes,” many ETFs replicate common indexes, such as the S&P 500 Index (Spiders, symbol SPY), Dow Jones 30 Industrial
Average (Diamonds, symbol DIA), or NASDAQ 100 Index (Cubes, symbol QQQQ). Unlike mutual funds, ETFs trade throughout the day on major stock exchanges.

As of October 2004, according to the Investment Company Institute, there were 149 ETFs trading on U.S. exchanges, with 101 tracking domestic indexes, 42 tracking foreign indexes, and six focused on bonds. Those interested in a particular sector—such as biotechnology, real estate, Japanese stocks, or gold—find ETFs a helpful way to invest without having to make buy and sell decisions on individual stocks or bonds.

Annual expense ratios on ETFs are low, ranging from 0.10 percent to 0.65 percent annually, which is lower than all but the least expensive no-load index mutual funds. ETFs typically are much more tax efficient—an important consideration for a taxable investment account—and they carry no front- or back-end load, unlike many mutual funds. Although some mutual funds require minimum investments of $1,000 or more, you can buy a single share of an ETF for its market price plus commission. In early December 2004, Spiders were trading for $120 a share, so an individual with limited means could get started with about $130, assuming a $10 commission through a discount broker.

* When do ETFs make sense? Because you must pay a commission each time you buy or sell ETF shares, they are best used as long-term investment tools with large, infrequent purchases. Watch commission charges, and consider using a discount broker to purchase ETFs if you are a do-it yourselfer. ETFs are useful tools for replacing higher-cost specialty or sector mutual funds, such as health care funds, because of their rock-bottom expense ratios and tax efficiency. Be aware that not all ETFs are equal. Although some fully replicate an index, others invest in a “representative sample” of their target index and are allowed to invest up to 5 percent of their assets in other holdings, and non-ETF investments sometimes are marketed as ETFs. Read the fine print before you buy.

— Former Army Capt. Phil Dyer, CFP, is deputy director, Benefits Information. For additional financial counseling, MOAA members can contact Garrett Planning Network (GPN) at (866) MOAA-GPN (662-2476) or online at www.garrettplanning.com.