investing

Should I invest in ETFs?

Investors also need to be cognizant of bid-and-ask spreads. "That little gap is a trading cost to you. You have to make sure that gap is narrow," says Iachini, who recommends using limit orders.

What is the track record of the ETF?

An ETF may not trade as close to an index as an index mutual fund. This is called a tracking error, and you want that number as small as possible, says Iachini. "If a portfolio is too small, it might be hard for the ETF manager to fully replicate the index."

Also look at whether the price matches the net asset value.

"Generally speaking, ETFs tend to trade very close to their net asset value -- that is one of the nice features of them. But that doesn't always hold, and it tends to break down a little bit whenever the underlying securities in the ETF become really hard to trade," says Iachini, citing high-yield bond funds during the credit crisis of 2008 as an example.

In evaluating a fund, investors can see the ETF price compared to net asset value on the previous market day. Depending on the tools they have available, it's possible to see it intraday through the Intraday Indicative Value.

One way to hedge against these risks is to choose funds with at least $20 million in assets, though more is better, Iachini says.

What about other risks?

Sector ETFs, such as commodities, currencies and country-specific ETFs, come with their own unique set of risks that individual investors should understand before plunging in. But what about all the scary media reports about ETF risks? "Concerns about ETFs are often overblown, but not in every case. There are certain reasons investors should pause, especially with exotic ETFs," says Iachini.

Exotics would be leveraged and inverse ETFs, which are designed to invest using borrowed money or move in the opposite direction of the market. They have attracted warnings from the Securities and Exchange Commission, the North American Securities Administrators Association, or NASAA, and a host of international agencies. "These exotic ETFs are beyond the ability of mom-and-pops to evaluate or hold," David Massey, president of the NASAA, told USA Today in June.

Fortunately, with the surge in ETFs has also come a deluge of investor education. Schwab, TDAmeritrade, BlackRock, State Street and Vanguard have loaded up their websites with analyses and tools. Large research firms such as Standard & Poor's and Morningstar, the fund watcher, are ramping up ETF coverage, as are specialized firms like IndexUniverse.

"Risk itself is not the enemy, it's just making sure you understand … on the other side of risk is also opportunity. Every investment has an element of both," says Demmissie. "It's all about making sure clients educate themselves (about ETFs) and go into an investment with eyes wide open."

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