MAGAZINE   January Magazine Contents Web Links Past Issues Try a Free Issue Customer Service Feedback GETTING STARTED   STOCKS Build a Strong Stock Portfolio Four Questions to Ask Before You Buy How to Make Sense of the Earnings Report   FUNDS Growing a Fund Portfolio Pick Funds the Right Way Time to Ditch Your Fund?   BONDS Add Balance with Bonds Bonds Made Easy MORE... TOOLS   STOCKS Kiplinger's Stock Finder Test your risk tolerance Pick the Best 'Bankerage' Company   FUNDS Kiplinger's Mutual Fund Finder Which fund is better? How do growth and income funds compare?   BONDS Which bond is better? What is my bond's yield to maturity? What price should I pay for a bond?

FUNDS
Are ETFs still right for you?
by David Landis

For frugal fans of indexing, picking an exchange-traded fund over the equivalent mutual fund isn't the no-brainer it used to be. That's because a round of fee-cutting has made some index funds as economical as their ETF rivals -- and some even cheaper.

ETFs and index mutual funds both invest in stocks that follow a market benchmark, such as Standard & Poor's 500-stock index. Because their stock universe is preselected, index funds and ETFs usually charge fees far lower than those of actively managed funds.

Nearly identical

But a recent move by Fidelity to trim fees on four index funds blunts what had been a major advantage of ETFs. With expense ratios of 0.10%, the funds take just $1 yearly for every $1,000 invested. (E*Trade one-upped Fidelity by cutting fees on its S&P 500 and foreign index funds to 0.09%.) Fees charged by Fidelity's Spartan 500 Index (symbol FSMKX; 800-343-3548), which tracks the S&P 500, are now on par with two similar ETFs: iShares S&P 500 Index (IVV) and SPDR 500 (SPY), which charge 0.09% and 0.10%, respectively. (The latter type of ETF is often called a Spider.)

With the numbers so close, you'll have to weigh other factors to determine the better choice. The downside for ETFs is that, because they trade like stocks, you must pay a commission each time you trade. By contrast, you can buy or sell the Fidelity funds without paying commission. A plus for ETFs is that you can trade them any time the market is open. You can generally buy and sell regular funds just once a day, and fund companies discourage frequent trading.

High initial minimums also argue against regular funds. Fidelity requires $10,000 to invest in its Spartan line -- although the index-fund leader, Vanguard (800-635-1511), lets you in with just $3,000 (its Vanguard 500 Index charges 0.18% per year). Minimums are lower for retirement accounts. But you can buy as little as one ETF share at the going rate (recently $119 for the S&P ETFs), plus brokerage costs.

Overseas edge

Fidelity's price edge is greatest in the foreign arena. With annual fees of 0.10%, Spartan International Index (FSIIX) charges one-fourth percentage point less than its ETF counterpart, iShares MSCI EAFE (EFA). What does that difference mean to you? Say you invest $25,000 in the Fidelity fund and $24,990 in the ETF (allowing for a $10 commission). If over the next five years the EAFE index returns 10% per year before expenses, and both vehicles track EAFE precisely, your Fidelity fund will be worth $470 more than your ETF.

But ETFs are still cheaper in many specialized sectors. In tech, for instance, the cheapest ETFs are Technology Select Sector Spider (XLKA) and Vanguard Information Technology Vipers (VGT), each with a yearly fee of 0.28%. The cheapest regular tech fund is E*Trade Technology Index, with an annual fee of 0.60%.

--Research: Amy Esbenshade Hebert