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Average Investors Uneducated About ETFs: $464 Billion Industry Has Room for Even Greater Growth


More than half of mutual fund investors don't know the difference between a mutual fund and an exchange-traded fund, but a recent survey found that many investors are interested in learning more about them and would consider buying ETFs if their financial adviser suggested it.

So, while ETFs have burgeoned from one fund with $464 million in assets in 1993 to 359 funds with $423 billion at the end of 2006, their popularity has room for even faster growth.

"There is a lack of understanding about how ETFs are structured, how they work, how they are traded and how they differ from mutual funds," said Tim Meyer, ETF business manager for Rydex Investments, the survey's sponsor. Rydex currently has 31 ETFs with $5.8 billion in assets under management.

"But investors are willing to learn more about ETFs," he said, adding that financial professionals can take advantage of this opportunity to increase assets under management by educating clients.

Fifty-three percent of mutual fund investors don't know the difference between a mutual fund and an ETF, and 38% don't even know what an ETF is. Sixty-three percent of investors said the main reason they don't invest in ETFs is because they don't know enough about them, but 35% said they would like to learn more, and 51% said they would consider investing in ETFs if their adviser suggested it.

ETFs have exploded in popularity among professional investors and fund managers in recent years, and the market is crowded with similar products, said Stewart Welch, founder of Birmingham, Ala.-based wealth management company The Welch Group.

"In the professional world, they are moving billions of dollars," Welch said, "but the general public is just beginning to figure out what they are."

"Many investors tend to think of ETFs and mutual funds as the same thing," said Daniel Candura of Braintree, Mass.-based Candura Group.

"There are currently over several hundred ETFs, with more being issued each week," said Dave Fry, founder of the website ETF Digest. "ETFs today cover a broad range of market sectors, including bonds, utilities, value, growth, small-cap, technology, technology sub-sectors, energy, gold, overseas markets and many more. Unfortunately, there are now too many repetitive ETFs, so it has become more critical for investors to choose their ETFs carefully."

ETF fees are generally half that of conventional index funds and are 75% cheaper than fees charged by actively managed mutual funds, Fry said.

In addition to low expenses, ETFs are easy to buy and sell, and offer tremendous transparency, liquidity and opportunities for diversification, he said.

Unlike most mutual funds, which can be purchased or redeemed only at the end-of-day closing price, ETFs are continually priced and can be traded throughout the day. However, 69% of those surveyed by Rydex didn't know how often an ETF is priced, while 31% knew they are priced continuously.

ETFs can be borrowed and sold short, making them excellent hedging vehicles, though they offer increased risks and costs. While ETFs have lower annual expense ratios than other investment products, transaction costs from frequent trading can offset the benefits of those low ratios, according to Rydex.

Overall, 20% of investors have ETFs in their portfolios, according to the Rydex survey. Twenty-five percent of investors with investible assets of more than $500,000 own an ETF, and an additional 18% of that group said they would consider investing in an ETF.

The survey did not find a connection between investors' wealth range and their knowledge of ETFs, though younger investors were more likely to be knowledgeable. Seventy-seven percent of investors over the age of 65 don't know the difference between ETFs and mutual funds, while 80% of investors under the age of 30 said they would invest in ETFs if their adviser suggested it.

Rydex decided to commission the survey when it sensed many of its clients had very little knowledge about ETFs, such as how to buy them or how they are priced, and wanted the survey to establish quantifiable results. Rydex responded to these results by creating ETF Essentials, an educational program available on its website.

"ETF Essentials has been a great door opener," Meyer said. "This program has also been a very effective tool for wholesalers."

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