“There is no better way for individuals to build diversified investment portfolios. Every asset class is available at rock-bottom costs.”
– Charles Schwab, founder and chairman of Charles Schwab Corp.

After all these years, it is nice to know that sometimes Wall Street’s financial engineers invent something worthwhile. I am referring to exchange-traded funds, essentially a mutual fund that is traded on a stock exchange.

The approximately 1,000 ETFs enjoy the following benefits:

Lower fees than mutual funds — 0.50 percent — one-half to one-third the fees of many mutual funds — and many ETFs charge 0.10 percent or less.

Transparency of investments.

Broad diversification.

They can be purchased or sold whenever exchanges are open, whereas mutual funds can be traded only once a day.

Through ETFs, one can purchase securities in every major market and asset class in the world.

As of Oct. 31, ETFs held $940 billion of assets in the United States. ETF trading averages $62 billion a day, about 25 percent of the volume on U.S. exchanges.

Yet the investing public remains largely ignorant of ETFs. Peter Crawford, a senior vice president of the Schwab client group, said, “If you asked eight out of 10 people, they probably wouldn’t know what ETF stands for.”

Although the first American ETF was created in 1993, I was unaware of their existence until I was selected to be on the board of directors of the Bear Stearns ETF “YYY” in the fall of 2007. To get myself up to speed, I put in a few late nights. Although my epiphany took longer than St. Paul’s, I have now become a believer.

The following are four of the 14 ETFS that I own personally. They show some of their diverse offerings.

Powershares Exchange-Traded Funds (ticker symbol PCEF), which holds interest in 71 closed-end, fixed funds that employ various investment strategies.

SPDR S&P Dividend ETF (SDY), which focuses on higher-yielding stocks.

Vanguard Information Technology (VGT), which focuses on high-technology stocks.

Wisdomtree Emerging Market (DGS), which focuses on large capitalization stocks in emerging markets.

Critics of ETFs worry that they can contribute to the bubble in some commodities.

ETFs make it easy to effectively purchase commodities such as silver or gold. The largest commodity ETF, the SPDR Gold Trust (GLD), holds $60 billion of gold in its London vaults. Its popularity could have contributed to the 25 percent rise in gold’s price this year to about $1,365 an ounce.

And ETFs might not always accurately track what they are intended to mirror. Because they trade as stocks, they are subject to the pressures of demand and could sell for more than the worth of their actual assets or less than the worth of their actual assets.

Investors should also be aware that ETFs run the risk spectrum from conservative to highly leveraged bets. Some ETFs are designed to move two and three times the daily change in their underlying indexes by using leverage or financial derivatives.

In an article published in Barron’s on Monday, “ETFs’ Explosive Growth, and Why It Matters,” Barron’s editor and president Edwin Finn Jr. gave a backhanded compliment to ETFs”

“At Barron’s, we’ve always believed that smart individuals and their advisers can beat the market, whether by choosing great stocks or by picking adept mutual-fund managers. We still do believe that, and we spend a lot of our energy helping our readers get smarter about stocks and mutual funds. But it’s impossible for us to ignore ETFs. They are cheaper for consumers than mutual funds, and they can be traded all day long, not just at day’s end. For investors who want to bet on certain sectors, commodities or countries, ETFs are tough to beat.”

Originally published in the Sarasota Herald-Tribune