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Test Your Knowledge of ETFs

the editors of Kiplinger's Personal Finance

With total global assets topping $4 trillion, exchange-traded funds are quite the popular investment these days -- and for good reasons. They have several advantages over traditional mutual funds, although they also have a few drawbacks. This quiz delves into the details. See how well you know ETFs by answering our 10 questions.

1: The first ETF was listed in what country?

  1. A. United States
  2. B. Cayman Islands
  3. C. Canada
  4. D. Switzerland

The correct answer is C. C. Canada

The first ETF was listed in Canada in 1990 as a quick way to buy and sell baskets of stocks on the Toronto Stock Exchange. The first U.S. ETF made its debut in 1993. It tracked the Standard & Poor's 500-stock index.

2: Low expense ratios are a big reason to love ETFs over traditional mutual funds.

  1. A. True
  2. B. False

The correct answer is A. A. True

The average expense ratio for an ETF that tracks a broad mix of U.S. stocks is 0.40%. That means for every $1,000 worth of an average ETF you own, you pay just $4.00 in expenses annually. Diversified no-load index mutual funds holding U.S. stocks charge an average of 0.41%, according to the Investment Company Institute. Diversified U.S. no-load actively managed mutual funds have an average expense ratio of 0.91%.

3: Is cost the only advantage ETFs offer over traditional mutual funds?

  1. A. Yes
  2. B. No

The correct answer is B. B. No

ETFs represent a hybrid of investing ideas: Like index mutual funds, most ETFs own a basket of stocks, bonds or other assets that mimic a benchmark, such as the S&P 500. This diversifies risk by bundling investments in many companies rather than just one. But like stocks, ETF shares trade throughout the day on an exchange. You buy and sell them through a broker. Traditional mutual funds are priced just once a day at 4 p.m. Eastern time.

4: ETFs track only U.S. stocks and only major market benchmarks, such as the S&P 500 index.

  1. A. True
  2. B. False

The correct answer is B. B. False

ETFs track everything from Turkish stocks to wind-power companies to the price of livestock. It's another appealing feature for investors who like to put their money into investments they feel they know something about. At the end of July 2019, there were 7,888 exchange-traded products trading worldwide, according to research firm ETFGI.

5: What's the biggest drawback of ETFs?

  1. A. Pesky brokerage commissions
  2. B. You can't hold them in an IRA or 401(k)
  3. C. They have expiration dates

The correct answer is A. A. Pesky brokerage commissions

Brokerages charge a commission for the transaction when you buy ETFs. It's not a big deal if you buy a lot of shares at once, but it can be expensive to purchase a small number of shares. A $10 commission on a single $40 ETF share would immediately put you 25% behind, for example. If you can only invest small sums, a few brokerages offer certain ETFs commission-free. It's worth checking around.

6: ETFs are less tax-efficient than actively managed mutual funds.

  1. A. True
  2. B. False

The correct answer is B. B. False

Like mutual funds, most ETFs have to distribute net realized capital gains to shareholders. However, since most ETFs tracks indexes they tend to make few trades. That's not usually the case with actively managed mutual funds. Further, ETFs don't always have to sell holdings when investors cash out, as can happen to mutual funds when many investors redeem shares at the same time. (Of course, if you invest through a tax-advantaged vehicle, such as an IRA, you don't have to worry about distributions.)

7: When comparing ETFs, investors should consider ...

  1. A. The expense ratio
  2. B. The underlying index
  3. C. Fund size
  4. D. All of the above

The correct answer is D. D. All of the above

Costs, the underlying index and the size of the ETF are all important considerations. For instance, two small-cap ETFs might track different indices, which could hold different-sized companies depending on their definition of "small cap," or could offer higher or lower exposure to certain sectors. As for size specifically, larger funds in general are more liquid and easier to trade.

8: Can a regular mutual fund that owns stocks and bonds also own ETFs?

  1. A. No, never
  2. B. Only if they are managed by another fund company
  3. C. Yes, of course
  4. D. Yes, but not if the ETFs use leverage or other trading strategies not allowed in the fund itself

The correct answer is C. C. Yes, of course

ETFs are publicly traded securities, with daily pricing and liquidity, so they meet funds' eligibility requirements. Some mutual funds that own ETFs just want to have an allocation to an index. ETFs give institutions the ability to buy and sell a whole sector or market throughout the trading day.

9: You are qualified to invest in ETFs if you ...

  1. A. Have at least five years of investing experience
  2. B. Have at least $1 million in assets
  3. C. Have a pulse
  4. D. Are a certified financial planner

The correct answer is C. C. Have a pulse

Anyone can invest in ETFs. You need only enough money to buy a share to get started, and you don't need a PhD to understand the benefits of simple, low-cost index investing.

10: What do ETFs not track?

  1. A. Robots
  2. B. Stocks that Warren Buffett owns
  3. C. The Swedish krona
  4. D. The Peruvian stock market

The correct answer is B. B. Stocks that Warren Buffett owns

Most ETFs cover familiar categories, from major stock benchmarks such as the Dow Jones industrial average to precious metals such as gold. A few, though, are quirky. Some track robotics stocks, obscure currencies or other thin slices of the market. However, none tracks the official holdings of the Oracle of Omaha.


Copyright 2016-2019 The Kiplinger Washington Editors