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ETFs

Question: I've just opened a Roth IRA to start saving for retirement. However, as a graduate student, the amount I'm starting with and able to contribute monthly is well below the minimum investments for various mutual funds. I've been looking at ETF's, which seem to have the same diversification with lower expense ratios. Is there a reason to prefer one over the other that I'm not seeing? Thanks much. Drew, Atlanta, GA

Answer: The exchange traded fund (ETF) is a genuine innovation. ETFs are investment vehicles that track indexes but an ETF is traded like a stock. The most popular ETFs are based on broad stock indexes such as the S&P 500 and the Dow Jones Wilshire 5000. There are also a number of broad-based socially responsible ETFs. It's also another way for the small investor to take a plunge in windmill energy, solar and other energy alternatives.

Problem is, there has been an explosion of ETFs that slice and dice the market into smaller and smaller and smaller pieces. Intrigued by patents? There's an ETF for you. Think the Austrian economy is poised to rebound? Yes, there's an Austrian ETF. That's why I'm cautious with ETFs in general. It's a product increasingly designed for speculation, not investing.

That said, an ETF is fine if you want to buy a broad-based index all at once. You pay the brokerage fee, and then hold on to the investment. An ETF works for a buy-and-hold strategy. But a no-load equity index mutual fund is better if you're adding to the investment in small increments over time, say, $100 a month or a similar investment disciple.

About the author

Chris Farrell is the economics editor of Marketplace Money.

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