Fund for the Whole Family

Suddenly, everyone's talking about exchange-traded funds. Are they right for you?

THE RISE IN ETF popularity by no means signals the end of mutual fund investing as we know it. Considering that ETFs carry brokerage fees, ultralow-fee index funds are still the more affordable option. But with discount brokers offering ETFs on the cheap, underperforming funds with high fees should consider themselves on notice.

The big mutual fund families have no intention of being left out of the ETF bonanza. Before this year Vanguard, the pioneer of index investing, offered two ETFs — or, as it calls them, Vipers (short for Vanguard Index Participation Equity Receipt Shares). Its Total Stock Market Vipers (VTI) track the overall stock market, while Extended Market Vipers (VXF) follow small-cap and midcap stocks. The fund giant made big news in January when it launched 14 new Vipers and announced plans to introduce six more later this year. Of the 14 new ones, six are exchange-traded shares of existing index funds, and the remaining are offered in conjunction with a large-cap index fund and a series of sector funds.

Fidelity Investments, meanwhile, launched its first ETF, the Fidelity Nasdaq Composite Index Tracking Stock (ONEQ), late last year. The ONEQ, as Fidelity's ETF is called, tracks the entire Nasdaq Composite, some 3,300 stocks. At the end of March 2004, it totaled $120 million in assets. It would seem to go head-to-head with the ever-more-popular Qubes (more than $23 billion in assets). But while the Qubes track the Nasdaq 100, the ONEQ offers exposure to all the small-cap and midcap stocks that are left out.

Ultimately, industry watchers say, major fund families will need to adopt this type of inclusive approach to stay relevant. As investors become savvier about their money, they will demand a wider range of products that better suit their needs. And that includes ETFs. "I think fund groups need to understand how ETFs work and how their products can complement them for the individual investor and the adviser," says David Haywood, director of alternative products research at Financial Research Corp.

Because of the costs and the regulatory hurdles involved, it's likely that only the big financial institutions, such as Fidelity and Vanguard, will be able to roll out ETFs. And few experts expect ETFs to be offered in 401(k) programs anytime soon. Not only does the existing 401(k) fund-buying structure not lend itself to ETF purchases, but also there's little incentive on the fee front for retirementaccount managers.

But that shouldn't prevent individual investors from considering ETFs. With so many advantages and so few drawbacks, these are investment products that demand attention.