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Fund Spy

Exchange-Traded Fund Myths Busted

We've sorted facts from fiction amid the ETF hype.

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It seems like I can't open a newspaper these days without reading about how popular exchange-traded funds are or how much better they are than regular mutual funds. Some of this is true, but some of it is just hype. Because one of the easiest ways to lose money is to misunderstand your investments, I'll use this month's ETF Spy to dispel some popular misconceptions about these vehicles. Here's the straight dope on a few ETF myths.

ETFs are getting all the fund flows.
They're getting a lot, but not all. Altogether, ETFs had about $251.5 billion in assets at the end of August 2005 compared with traditional mutual funds' $8.5 trillion, according to the Investment Company Institute. ETFs also netted about $18 billion in new money in 2005 through the end of August, the ICI says. That's about 11% of all new money in any kind of fund, exchanged traded or otherwise. So, yes: You can say ETFs are hot sellers, but they're certainly not gobbling up everything.

ETFs must perform better than mutual funds.
There is nothing about ETFs that guarantees they'll perform better than traditional mutual funds. Currently, just about all ETFs are index funds. Like their conventional index fund counterparts, they try to mimic the returns of their benchmark indexes. When the indexes do well, so should the ETFs that track them. When the benchmarks do poorly, so will their corresponding ETFs. Low costs and diversification give ETFs a very good shot at beating the average comparable actively managed fund over the long term, but you could say the same for many regular, no-load index mutual funds.

Dan Culloton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.