As a relatively new star in the financial universe, exchange-traded funds – or ETFs – have been getting a lot of attention lately. I still remember when the first ETF – the S&P 500 index-tracking SPDR – was launched in 1993. Since then, they’ve skyrocketed into the stratosphere, with trillions of dollars invested in them.

But what does that mean to you and your investments? In this “No Dumb Questions” segment, I’ll explain how new doesn’t always mean improved, and why popular doesn’t always mean better when picking products for implementing your sound investment strategy.

Exchange-Traded Funds

Suffice it to say, Wall Street and Bay Street knows a bandwagon when it sees one … and it looks like the ETF party bus is just getting rolling. A recent InvestmentNews article reported that 260 new ETFs have debuted during the last 12 months alone. [Source] If you knock off for weekends, that means somebody launched a new exchange-traded fund every business day from September 2015 thru September 2016. When you’re spewing out products at that pace, you have to wonder what is coming off the assembly line.

But I get ahead of myself. What is an exchange-traded fund, and how is it different from a mutual fund? Actually, the two fund structures share more similarities than differences, so let’s start with three ways ETFs and mutual funds tend to be matchey-matchey:

  • With both, you pool your money with other people’s money in a shared “basket” of securities.
  • Both can offer broad, relatively cost-effective exposure to far more individual holdings than you’d want to manage on your own.
  • You make money on your investment if you sell your fund shares for more than you paid for them.

The biggest difference is in how these otherwise similar investments are priced and traded.

Mutual Funds

In a mutual fund, the fund manager sets share values daily, based on what all of the fund’s holdings are worth when the market calls it quits for the day. Whether you press the “buy” or “sell” button at 6 am, 3 pm or 11 pm the night before, you’ll be trading at the exact same end-of-day price.

With exchange-traded funds, as the name suggests, you or your broker are trading on a public exchange – just as if you were trading individual stocks. And, just like with stocks, an ETF’s share price is constantly changing. Its mid-day price probably won’t be the same as the opening or end-of-day price. As described on ETF.com, “You can buy shares in the morning and sell them in the afternoon. You can buy them at 10 a.m., sell them at 11 a.m. and buy them again after lunch if you want.”

I could easily stop right here and publish a War-and-Peace-length treatise to cover the countless ways this essential difference can be used – or abused – by fund providers, brokers and investors alike. Suffice it to say that, for mutual funds and ETFs alike, there are products and pricings that range from relatively reliable to cuckoo-clock crazy … and the intra-day pricing for ETFs only adds to the potential complexities. We’ve seen some new-fangled ETFs that we wouldn’t recommend even if there were a hazmat suit to go with, as they chase ever-thinner market sectors that seem just as likely to melt down as to explode. From 3-D printers to drones to food fads, if there are hot sectors to be pursued, chances are you’ll find an ETF leading the charge.

The point I want to make today is how to consider an ETF investment in the much greater context of your investment strategy.

You do have an investment strategy, right? Whether you’re investing in stocks, bonds, funds or flying machines, volatile markets are no place to enter without a plan to guide the way. As our friends from Dimensional Fund Advisors shared in this handy visual, successful investing is about mapping out a successful journey toward your desired end.

By focusing on these steps to success, it becomes easier to differentiate the qualities to seek in any product you may use to implement your plans, whether that’s an ETF, a mutual fund, or the next big invention that has yet to be created.

In my next post, I’ll take a closer look under the hood of the evidence-based investment vehicles that I feel are best designed to help you go the distance with your wealth. If you come up with other questions in the meantime, please send them my way!